Current Account Mortgages

One of the principles of good financial planning is that it is not sensible to have both loans and investments in the medium term, unless you hope the investment will outperform any loan interest.  If it doesn’t, then you might as use the investment to pay off the loan, as you will “save” money instantly.

It always surprises me to see so many people with building society or bank deposits earning them paltry interest rates, when they owe their credit card company money, which costs them interest of over 20% in some cases.  It is clearly more sensible to repay the credit card loan with the deposit, unless the deposit is for a special, short-term reason.

The current account mortgage was first offered in the UK by Virgin One, although other lenders claim to have similar schemes.  It is a flexible mortgage scheme run from a current bank account.  It is like having a cheap overdraft on guaranteed terms.  The only stipulations are that the loan must not exceed the pre-agreed maximum and it must be repaid (by any method) by the end of the pre-agreed term.  In between time, you can take money out or put money in however you like: interest is calculated daily.  The “reserve” is the amount you could draw on if you wished.

A current account mortgage will provide the facility of managing your “quick access” savings as well as all your loans – mortgage or credit card.  When your pay comes in at the end of the month, it is used to immediately reduce your mortgage debt, albeit perhaps for a week or two only.  The effective “deposit” rate of interest is the same as the mortgage rate.  If you borrow at 7% pa, your “deposit” will earn 7% - tax free, equivalent to 8.75% pa gross for a basic rate (20%) taxpayer, or 11.67% pa gross for a 40% taxpayer.  It is impossible to get a better deposit rate that the equivalent of the interest rate on your debt.

If everyone did this, there would be no conventional deposits left from a large cohort of borrowers:  the banks would lose the “turn” they otherwise make on the difference between the deposit and the lending rates.  If this idea was rolled out to everyone, it could be costly for the banks, unless they increase the lending rate, which they probably would.  Moreover, there is an administration cost to such lenders, which must be covered by the lending rate.

Evaluating current account mortgages
It is very difficult to evaluate this type of loan.  The IRR and the quoted APR are usually a bit higher than normal schemes, but it is only when you use the “investment” facility that it becomes worthwhile.  Borrowers who are unlikely to be able to exploit this facility may be better off with a flexible mortgage.

You can look at it this way.  Suppose you normally use a deposit account and also expect to receive investment interest on your current account too.  First evaluate the likely interest you would conventionally earn overall, in say a year.  Say this came to £1,000. 

If your savings pattern remained the same, you would obviously earn a higher effective investment rate if you switched to a current account mortgage, say £1,500.  So you could save £500 each year in this example.

If your mortgage was £50,000, this £500 saving is approximately equivalent to a 1% pa rate reduction.  I must stress that this is a simple example, with deliberately simple figures.  Every individual will have a different profile, and it requires a personal calculation.  The “savings effect” reduction must then be offset by any “loading”, or higher mortgage rate charged by current account lenders, compared with an alternative, competitive mortgage product. 

As another way of looking at a current account mortgage, imagine you borrow £50,000.  But because you “deposit” say £5,000 on average each month, due to your monthly pay, or from transferring from other lower-interest deposits, you pay interest on only £45,000 – 10% less.

There is always the risk that the projected pattern of savings does not actually arise and that any potential is not actually realised in the future.  But if used correctly, and with some more competing lenders in the field to keep the rates competitive, this mortgage method has much to commend it, particularly if it can be managed over the Internet.