But the soaring cost of living is just the tip of the iceberg. With interest rates still slumped at historic lows of 0.50%, already paltry returns on savings accounts are wilting further now inflation is eroding them as well.
According to research from moneysupermarket.com, the average rate on the five top-paying easy access savings accounts has plummeted from 3.04% to just 2.86% since the start of the new year. This means that, combined with rising inflation and tax payable on interest earned, savers are finding it impossible to get any ‘real’ return on their cash at all.
For example, basic rate tax payers will now need an account paying at least 4.62% to gain any financial benefit. And for higher rate tax payers, this minimum shoots up to 6.17%. Yet, of the 262 easy access savings accounts for balances of £1,000, not a single one pays enough interest to negate the combined effects of inflation and tax.
Making the best of a bad situation by continuing to shop around for the highest-paying accounts is clearly the first step for savers. But if you’re a homeowner too, now could also prove the perfect time to switch to an offset mortgage deal.
Just as it says on the tin, an offset mortgage works by offsetting your savings – which must be held in a linked account with the same lender – against the debt of your mortgage.
You won’t earn interest independently on your savings pot; instead the balance is deducted from the debt. For example, if you had £10,000 in savings and a £150,000 mortgage debt, you would only be charged interest on the remaining £140,000.
At times like the present, when interest earned on savings after tax can become lower than the interest you fork out on your debt, an offset arrangement can make perfect sense.
Saving, rather than earning, interest
The effect of saving, rather than earning, interest can be very significant. For example, if you took out a £150,000 loan with First Direct’s offset lifetime tracker deal (priced at 2.39%) and held a consistent £10,000 in the linked savings account, you would save a total of £3,418 in interest and see 1.6 years lopped off the term of your mortgage.
As ever, the more money you have, the cheaper debt becomes. For example, if the same borrower held a fixed £20,000 in savings, they would save £6,387 in interest and repay the loan three years ahead of schedule. And with £50,000 held in savings, the total interest saved would be a whopping £13,340, with the mortgage repaid 6.3 years head of schedule.
Hannah Mercedes-Skenfield, head of mortgages at Moneysupermarket, said: “Now inflation is eating away even harder at falling returns on savings, the spotlight has been turned back on the benefits of offset mortgages. Higher-rate taxpayers in particular can really benefit from offsetting because the fact you don’t earn interest on your savings means you don’t pay tax on them either.”
She added, however, that an offset deal won’t make sense for every borrower in every situation. The value will rely on a combination of the proportion of your mortgage debt you hold in savings and the rate payable on the mortgage. Number-crunching can get a little tricky, so it could make sense to visit an independent mortgage adviser to see if an offset makes sense for you.
The top offsets in the running
One thing is certain though – the lower the interest charged on your mortgage the better which, of course, still means shopping around for the best deal. Top of the offset tables currently is First Direct’s lifetime tracker priced at 2.39%. The deal comes with a £999 fee and requires a 35% deposit. As well as the cheap rate, the mortgage does not impose early repayment charges meaning a borrower can leave at any time cost-free.
For those who can only lay their hands on a 30% deposit, Woolwich is also offering a lifetime tracker offset deal. It comes with a rate of 2.89%, an arrangement fee of £1,499 and early repayment charges for the first three years.
Chris Keane, head of mortgage products at the bank, said: “We are seeing a lot of interest in offset accounts as borrowers think more holistically about their financial situation. The top priority of many customers in the current climate is to keep savings accessible which an offset allows. However, with interest rates at historic lows, there is also the opportunity to make big savings on mortgage repayments. Offset deals give the best of both options.”
Borrowers looking for a shorter term deal might consider Yorkshire Building Society. The mutual is offering a two-year offset tracker priced at 2.59% in return for a 40% deposit and £1,195 fee.
Please note: Any rates or deals mentioned in this article were available at the time of writing.