John Fitzsimons
With a regular mortgage, you are charged interest on the outstanding balance that you have borrowed for your house purchase, but offset mortgages work a little differently.
An offset mortgage links the sum you have borrowed with a savings account you hold with your mortgage lender. You are then only charged interest on the difference between the two. In effect, the money in your savings account is ‘offset’ against the size of your outstanding mortgage.
Some offset accounts let you link both your savings and your current account to your mortgage balance, meaning you may reduce the amount of mortgage you are paying interest on further.
Find out more about the pros and cons of offset mortgages and how they work below.
Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on a loan or any other debt secured on it.
How does an offset mortgage work?
Say that you have borrowed £200,000 to buy a property and have £20,000 in a separate savings account. If you take out a traditional mortgage, then you pay interest on the £200,000 you have borrowed. At the same time, but separately, you earn interest on the money you have in your savings.
With an offset account, your mortgage and savings are linked. So in our example, you would only pay interest on £180,000 of the £200,000 you have borrowed, but in return you would not earn any interest on the £20,000 in your savings account.
Offset mortgages are available on both a fixed and variable rate basis.
» MORE: Do I need a fixed or variable rate mortgage?
How much can you borrow with an offset mortgage?
Different lenders will have different limits on precisely how much they are willing to offer on their various types of mortgage.
However, the amount you can borrow with an offset mortgage ultimately comes down to your own finances and what a lender believes you can afford. All lenders are required to look in detail at your income and expenditure to get an idea of what you can afford to repay, not only today but in the future if interest rates increase.
» MORE: Am I eligible for a mortgage?
How much can you save with an offset mortgage?
If you have a significant amount of savings, an offset mortgage can make a difference to the size of your mortgage repayments, as well as how quickly you can pay off your loan.
Returning to our example above: if £200,000 was borrowed at 3% over a 25-year term (with the lender’s arrangement fees added to the mortgage), you would pay £948 a month, with the total mortgage costing around £284,400.
However, going with an offset mortgage at the same interest rate (with £20,000 in a linked savings account), our repayments would drop to £899 a month, while overall it would cost £269,700 – a saving of £14,700. This is because we would only be paying interest on £180,000 of the total loan balance. This calculation assumes you never touch the £20,000 savings pot.
There is flexibility in how you use an offset mortgage too. You could keep your repayments at the same level as they would be in a regular mortgage and shave time off how long it takes to repay the mortgage. So if we went with the offset mortgage but kept the repayments at £948, then the mortgage would be paid off one year and 10 months early, again saving in interest charges.
An offset mortgage can be quite a tax-efficient way to use your savings. Everyone gets a personal savings allowance, which means you can earn £1,000 from your savings before paying tax.
With an offset mortgage, you are still getting a return of sorts from those savings as it is helping cut the cost of your mortgage, but that return doesn’t count towards your saving allowance.
What are the downsides of an offset mortgage?
There are downsides to consider. An offset mortgage means you are giving up earning interest on your savings. This may not be an issue when interest rates are low, but may be in the event that interest rates – hence the amount your savings might earn – increase.
What is more, if you have to tap into those savings there will be a direct impact on the size of your monthly mortgage repayments. This would not be the case if you keep your mortgage and savings separate, as they would be in a traditional mortgage.
It’s also worth remembering that there isn’t a huge amount of choice when it comes to offset mortgages. They are a relatively niche product, with only a few mortgage lenders providing them.
It is worth noting that the actual interest rates charged on offset mortgages are typically higher than those levied on regular mortgage products. As a result, it’s important to do your sums to establish that you have enough in savings to make an offset mortgage worthwhile.
» MORE: Check the latest mortgage rates
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