Finding the right mortgage can be an intimidating task, especially when there are so many types to choose from. For instance, with a traditional mortgage, interest is charged on the total outstanding balance that you have borrowed for the house. Although traditional mortgages are most common, there are other viable options such as offset mortgages, and these work slightly differently.
An offset mortgage links the sum you’ve borrowed to a savings account that you hold with the mortgage lender. You will only be charged interest on the difference between the two. Essentially, your money in your savings account is ‘offset’ against the total of your outstanding mortgage.
Some offset accounts even let you link both your savings and your current account, reducing the outstanding mortgage balance, and therefore interest owed, further.
But there are some things to be aware of. In this article, we will explore in detail what an offset mortgage is, the pros and cons, and whether it’s the right fit for you.
What is an Offset Mortgage?
An offset mortgage is a type of mortgage that enables you to link the sum you’ve borrowed with a savings account. Your savings balance can effectively ‘reduce’ the mortgage, and you only be charged interest on the difference, resulting in a smaller sum. Therefore, this lowers your monthly interest payments and can result in you paying off your mortgage sooner.
Although it could make your mortgage interest repayments cheaper, you won’t earn interest on the savings account your mortgage is ‘offset’ against. But, since people usually pay more interest on a mortgage than what they earn from a savings account anyway, an offset mortgage could still save you money. The savings balance will act as a provisional ‘over payment’ – whilst also allowing you to dip into it when needed.
How do Offset Mortgages work in practice?
Now that we’ve established what it is, let’s look at an example to see how offset mortgages work in practice. Say that you have borrowed £250,000 to buy a property with an interest rate of 3%, and have £40,000 in a savings account with your mortgage lender.
If you take out a traditional mortgage, you will have to pay interest on the full £250,000 you have borrowed. At 3% interest, your annual repayments would equal £7,500. At the same time, but separately, the money in your savings account will earn you interest.
With an offset mortgage, since your savings account balance will ‘offset’ the borrowed amount, you will only have to pay interest on the remaining £210,000 (£250,000 – £40,000) of your mortgage. This would reduce your annual interest payments from £7,500 to £6,300 – a saving of £1,200.
However, because you’re no longer earning interest on your savings, this will have to be factored into the total amount saved. So, if you were earning 0.5% interest on that £40,000, or £200 annually, the total amount saved on your mortgage would be £1,000. But, keep in mind that if you choose to withdraw a sum of money from your linked savings account, then the amount of your monthly repayments will increase proportionately.
As you can see, an offset mortgage is a desirable option for diligent savers as it can considerably lower your monthly interest payments.
Can I still withdraw money from an offset mortgage savings account?
You can still withdraw money from your savings account. Having said that, taking money out of your savings will reduce the amount you can offset against your mortgage, and therefore your monthly interest payments will go up.
You may also be required to keep a minimum balance in your savings account. Before picking an offset mortgage deal, always check if there is a minimum balance requirement as this could greatly impact your mortgage decision.
Should you put down a bigger deposit instead of offsetting?
Unfortunately, there isn’t a simple answer to this question. Putting down a larger deposit will certainly lower the loan-to-value ratio (LTV) you’re borrowing at, which can result in getting offered better rates by banks.
On the other hand, keeping some savings back and placing them in a savings account linked to an offset mortgage will result in you paying interest on a smaller sum, but will also mean that you have access to the cash if you require it. This is a more flexible option, and something to consider if you think you may need cash in the near future.
Are offset mortgages tax-efficient?
For additional-rate and higher-rate taxpayers in particular, offset mortgages can be a tax-efficient way to utilise your savings. Since you won’t be earning interest on your cash, you won’t pay any tax on savings income, or use up your Personal Savings Allowance.
Therefore, your savings will still be generating a return for you – by bringing your interest payments down – without having to face a tax bill.
What types of Offset Mortgages are available?
- Fixed-rate offset mortgage: The interest rate you pay is set for a fixed amount of time that you agree with the lender beforehand. These rates are usually fixed for one, two, four or five years. Handy for those who want to budget each month and know exactly how much they will be spending.
- Tracker offset mortgage: The interest rate you will pay on the mortgage after it’s been offset by your savings can change, depending on the base rate set by the Bank of England. A potentially attractive option while the base rate is low, but if interest rates rise, then so will these payments.
- Discount offset mortgage: The interest rate you will pay on the mortgage after it’s been offset by your savings is given a set discount, based on the lender’s standard variable rate (SVR).
- Interest-only offset mortgage: You will only pay off the interest on the mortgage and would need another way of repaying the capital. The interest owed will be dependent on how much of your mortgage is offset by your savings. This kind of mortgage can result in lower monthly payments, but if the property loses value by the end of the mortgage term, then you will need to find extra money to pay off the mortgage.
- Family offset mortgages. Parents can put their savings in an offset account linked to their child’s mortgage. This reduces the child’s interest payments, potentially making it easier for them to get on the property ladder.
What is a current account offset mortgage?
Some offset mortgages allow you to combine your savings account with a current account to offset your mortgage, as long as they are with the same provider. However, these are very rare.
The main difference between current account mortgages and regular offset mortgages is that your current account and your mortgage are merged into one, instead of having two separate accounts.
Your mortgage is then held in a negative balance account, into which you can pay your wages and savings. But, while current account mortgages can aid with helping you pay off your mortgage faster, seeing a negative balance all the time can make things confusing.
Are mortgage rates higher with offset mortgages?
Typically speaking, offset mortgage rates do tend to be slightly higher than traditional mortgage rates, however, there has been a slight shift over the last few years. It’s worth bearing in mind that some lenders can charge a higher interest rate if you decide to reduce your monthly payments, or repay the mortgage quicker.
How can I benefit from Offset Mortgages?
There are numerous benefits to having an offset mortgage as opposed to a traditional one. Aside from your annual interest savings, an offset mortgage will also give you the choice between paying back the borrowed amount over a shorter term or lowering the monthly payments. This is because mortgage payments are dependent on the full amount as opposed to the offset amount, which means you are actually overpaying each month, thus reducing the length of time taken to pay off the total amount.
You could potentially shave off months or, even, years to your mortgage term. Alternatively, if you wish to save more money in the short term, the lender may allow you to adhere to standard mortgage terms, thereby reducing your monthly repayments.
The full range of benefits are listed below:
- Reduce your monthly payments. You can use the interest savings towards your mortgage repayment, therefore benefiting from lower mortgage payments, but keeping the same mortgage term.
- Pay your mortgage off sooner. You can use your interest savings towards your mortgage balance, benefiting from paying off your mortgage quicker, but keeping your monthly payments the same.
- Save on interest. You could save more on your interest than you would earn in a savings account.
- Flexible access to funds. In most cases, you still have access to your savings if need be, making your finances more flexible (always check the terms and conditions of your offset mortgage deal beforehand).
- Tax Savings. Offset mortgages can be tax-efficient if you’re a higher, or additional rate taxpayer. You will pay zero tax on the interest you save, as opposed to being taxed on any interest savings above your Personal Savings Allowance.
- Enable family to get on the property ladder. Some lenders will enable you to offset your savings against someone else’s mortgage, known as family offset mortgages. This could be a first-time buyer, such as your child or grandchild.
- Early Repayments. Offset mortgages will often allow you to make overpayments, but early repayment charges may apply.
What are the downsides of an offset mortgage?
As with all mortgages, there are downsides that need to be considered. You are foregoing any interest earnings on your savings. This may not be an issue when interest rates are low but could be a disadvantage in the event that interest rates – and thus your potential interest earnings – rise.
Additionally, if you tap into your savings, there will be a direct impact on your monthly interest repayments. This would not be the case if your mortgage and savings are kept separate, as with a traditional mortgage.
It’s also worth noting that due to offset mortgages being a fairly niche offering, only a few mortgage lenders are providing them. Due to the limited choice of lenders, you may find it difficult to find a mortgage deal to suit your needs.
The full range of downsides are listed below:
- No money earned from savings interest. Money put into a savings account linked to an offset mortgage does not earn interest. Therefore, your savings will lose their spending power as they will not grow.
- Savings withdrawals will increase mortgage payments. Due to your mortgage being offset by your savings account, if you withdraw money from it, your monthly interest payments will increase proportionately.
- Higher mortgage rates. Often, offset mortgage rates tend to be higher than traditional mortgage rates since you’re paying a premium for the offset and flexible features. It could be preferable to use your savings to reduce your LTV, likely giving you lower rates and thus lower interest overall. It should be noted that this isn’t always the case, and it is worth shopping around.
- Fewer optimal deals. Since the market for offset mortgages is small in comparison to traditional mortgages, it may be harder to find a rate or deal that is suitable for your needs.
- Large savings are required. An offset mortgage is better suited for those with a large savings balance since that will make more of an impact.
- Same provider. In many cases, the savings account and offset mortgage will need to be with the same provider.
Are Offset Mortgages the right option for you?
The answer to this question will vary depending on your circumstances. Your savings balance, how often you will be withdrawing from your savings, and your tolerance for risk, along with all the factors mentioned above, will determine whether an offset mortgage is the right option for you. Ensure all factors are considered since mortgages – offset or traditional – could have long-term impacts on your finances.