I recently wrote about the ability to protect your savings by taking an offset mortgage.  My mortgage broker friend has just given me an update to clarify the situation.

If you hold savings and debt (mortgage, loan etc) with a single institution then it is your NET position which is used to determine what you owe or are owed should the bank collapse.  This is not a feature of offset mortgages in particular but I mentioned them because the interest you save is tax free which is a nice bonus.  Anyway, here’s an excerpt from Barclays website:

The Financial Services Compensation Scheme (FSCS) is the UK’s statutory fund of last resort for customers of authorised financial services firms. Among other things, the FSCS protects customer deposits with authorised financial services firms. Barclays Bank PLC is an authorised financial services firm and so our customer’s deposits are covered by the scheme. The maximum level of compensation payable under the scheme for deposits is £35,000 per person. The level of compensation is effective since the 1 October 2007.  If a bank were to go into default, the FSCS would consider the overall net claim.

This means that if the claimant’s borrowings exceeded his/her savings, there would be no overall claim against the bank, and the claimant would not be entitled to any compensation. For example, if a customer had a mortgage of £200,000 and savings of £150,000 with the same bank, set-off would be applied As a result, the individual still owes the bank £50,000. There would be no positive balance and no claim. If, however, the savings exceeded the mortgage, the compensation rule of £35,000 would come into play.

So there you have it from the horse’s mouth.

There’s been so much interest in protecting savings that I had to mention this little known fact that provides 100% protection for savings.  First, I have to admit that I had not thought of it until my mortgage broker friend, Scott, mentioned it to me.

As you probably know the Financial Services Compensation Scheme (FSCS) covers bank deposits up to a maximum £35,000.  Now, if you have £100,000 saved, how do you protect that?  Some of you will spread it across 3 institutions with different savings accounts and that’s one method.  What if you have £350,000 saved though – are you going to open 10 different accounts?  Possible but annoying.

At the risk of getting sidetracked… one other thing to mention about the FSCS before I go on – although your money is safe, how long will it take to get back?  The wife of a friend of mine made a claim and got her £5,500 back but it took five and a half years!  Admittedly this was a good few years back but who’s to say they’re any quicker now?  And there was no interest paid on the £5,500 over that time.

Here’s how to get 100% protection for savings: take an offset mortgage and put the savings you want to protect in that account.  Offset mortgages work by offsetting your savings against your debt so as an example if you have a £300,000 mortgage and £100,000 savings then you only pay interest on £200,000.  Now, consider the mortgage rate (aside: I bet many of you are uncertain as to your exact mortgage rate at the moment!) as your savings rate since you are saving that interest on your mortgage payments.  It gets better too – as you are not actually earning interest but rather saving interest you would otherwise pay there’s no income tax to pay on it!  Tax free savings with 100% protection?

If your mortgage rate was 6% then this is the equivalent of a savings rate of 10% net of 40% income tax and for lower rate tax payers it’s still a very reasonable 7.5% net.  Where else can you get rates like that? And, because most offset mortgages let you take money back out as you need it you still have instant access to your cash.

Frankly, I’ve always been a fan of offset mortgages so I’m bound to like this but there is a potential downside too.  If your mortgage lender were to go bust – and given recent government action over Northern Rock and now Bradford & Bingley that seems very unlikely – your savings would be offset against your mortgage to reduce your debt rather than giving you cash back.  In other words, you’re forced to use your savings to pay off part of your mortgage.  But actually that would happen anyway if you had both savings and debts with a bank that went bust so it’s not a particular problem of offset mortgages.

So there you have it – 100% protection on your savings.

In recognition of my friend’s help in bringing this to my attention (and of his skill as a mortgage broker) I’m giving a link to Scott’s profile.