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Advisers at odds over value of offset mortgage
By Rebecca Knight
Published: October 8 2004
This article appeared in The Financial Times
Julia Haviland has made some big changes
in her life and wants to make sure her finances are in order. She and
her husband are divorcing and she has accepted a new job.
Julia lives just north of London and works
as a project manager in the chemical industry. She earns £54,000
a year plus a bonus of about £1,500. She is also given a £4,500
annual car allowance. Her new job working for a contract research organisation
offers slightly higher pay and a company car.
She has been legally and amicably separated
for about a year and a half. She and her husband are financially independent
of each other. Earlier this year, Haviland bought her husband's share
of their £300,000 house. Haviland is philosophical and practical
about her finances. “I've come to a point in my life where I know
that I am one of the lucky ones,” she says. “I've got a good
job that pays a decent salary and I have a nice house and I have my health.
But it still seems to be a great effort, especially when it comes to saving
for the future. I read newspaper articles about older people who are struggling
and I worry about how much my pension will be worth when I'm ready to
retire.”
Haviland's main concern is paying off the
mortgage of her three-bedroom home as early as possible. Two years ago,
she took out a 20-year £160,000 offset flexible mortgage. This allows
her to reduce the amount she owes by paying off lump sums and offsets
savings in her account against the balance outstanding when it comes to
calculating the interest she pays. The outstanding balance now stands
at £122,000.
Ben Gibbs, a certified financial planner
at Glazers Financial Services, says this type of mortgage has been successful
so far. “Flexible mortgages tend to have higher interest rates than
conventional mortgages, so you effectively pay more for having the flexibility
to pay off the amount you owe without incurring penalties,” he explains.
“Julia has used this flexibility to bring the amount outstanding
down from £160,000 to £122,000.”
He goes on: “As Julia is a higher
rate tax payer, an offset mortgage is useful from a tax point of view.
Any interest that she earns on savings is subject to be taxed at 40 per
cent, so it makes good sense to reduce the interest she is paying on her
mortgage rather than generate interest on which she would pay a significant
amount of tax.”
But Jonathan Davis of Professional Partnerships
Independent Financial Planning does not agree that an offset mortgage
is the right approach. “Offset mortgages can usually be beneficial
if there is a significant amount of savings in the account, generally
thought to be a minimum of 15 per cent of the mortgage balance,”
he says. “In Julia's case, she does not have significant savings
to benefit from the higher interest rate.”
Davis suggests that Haviland change her
offset account to a more conventional one. “After the end of the
reduced interest period, Julia should look to switch to a traditional
mortgage which offers a continuously lower interest rate because she is
not using the offset as it is designed,” he says. “The temptation
with offset mortgages is that you can simply write out a large cheque
for, say a new car, and you then find later you have not significantly
reduced the balance of the debt going into retirement.”
With regard to mortgage repayments, Stuart
Bryant of SDB Strategic Planners urges Haviland to plan for the worst.
“I am concerned that, in the event of a catastrophe, Julia may not
have sufficient critical illness cover or health insurance to provide
a replacement income,” he says. “Julia's current position
would not clear her current mortgage or indeed replace income in the event
of disability . . . I suspect she would need to consider disposing of
the property, perhaps an unacceptable option.”
Bryant therefore suggests that Julia consider
not only increasing her critical illness cover, but also a permanent health
insurance contract that could mesh with her contract of employment. “If
Julia's contract of employment would pay, say, for six or twelve months,
she could defer payments on the policy until her employer's responsibility
ceased. Permanent health insurance is not necessarily expensive, and with
a reasonable period of deferment, premiums could be accommodated quite
easily within Julia's budget.”
Julia is also eager to plan for her retirement.
“I'd love to retire by 55, but I don't know if it's realistic,”
she says. “The prospect of working until I am 65 is appalling.”
Julia contributes 10 per cent of her salary
into her pension fund and her employer gives 7 per cent. Her pension pot
is now worth about £7,605. She says she doesn't have extravagant
plans for retirement, but she'd like to maintain her current standard
of living. Julia, an avid cross country skier, says: “I love getting
outdoors and doing things. I'd like to think I could do that in my old
age, too. Nothing extravagant, just a couple of nice holidays a year.”
Gibbs says, that based on Haviland's current
contributions, she will have enough in her pension to generate a sufficient
level of income. He does, however, recommend that she increase her contributions
for tax purposes. “As a higher rate tax payer, Julia's pension contributions
have income tax relief at 40 per cent. Once invested, investments are
not subject to capital gains tax. When she takes money out of her pension,
she can take a tax-free cash sum,” Gibbs says. “Julia can
contribute up to 15 per cent under current Inland Revenue rules as an
employee.”
With regard to her new job, all three advisers
agree that Haviland should investigate her new pension scheme and the
options available to her. “Before starting her new job, she should
consider the type of pension arrangement, either occupational or personal
available, the level of personal contribution and whether this is compulsory
or voluntary, policy fees and management charges and finally the possibility
of her new employer contributing to her existing scheme,” says Bryant.
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