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Offset mortgages explained

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HomeFirst Time BuyersOffset mortgages explained

Offset mortgages explained

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Last updated on 15th August 2023 by Martin Alexander

If you have adequate savings in the bank, an offset mortgage could be something to consider. You may be able to reduce the length of your mortgage term and pay off your mortgage sooner than planned. That said, offset mortgages aren’t as readily available as regular mortgages. This is because most lenders don’t offer them, so your options will be limited.

What is an offset mortgage?

An offset mortgage allows you to link your mortgage to your savings account so you can offset the amount of interest you owe on your mortgage. This can be a great way to reduce the overall cost of your mortgage, but you won’t earn interest on your savings.

Rather than paying interest on your entire mortgage balance, you’ll be able to pay interest on your balance minus your savings. Because you’re paying interest on a lower amount, you’ll save money on your monthly payments. This doesn’t mean to say that your savings will be used to pay your mortgage. Your savings stay at their value and are used to calculate the amount you can offset.

It’s also possible to get an offset mortgage on a buy to let. Although few lenders offer them, they can be a great way for landlords to reduce costs.

How does it work?

Offset mortgages work differently from traditional methods of borrowing, such as repayment mortgages. With a repayment mortgage, you’d typically repay the capital and interest each month until repaid in full. With an offset mortgage, your savings are set against your outstanding mortgage balance to pay less interest.

How can I pay less interest with an offset mortgage?

An offset mortgage can be used to reduce your mortgage term and your payments. You may be comfortable paying your mortgage and have no desire to reduce your monthly payments. In this case, reducing your mortgage term will allow you to pay off your mortgage much sooner.

Take a look at this example:

Imagine your mortgage balance is £150,000, and you have £50,000 in a savings account. Rather than paying interest on the £150,000 you owe, you’d pay interest on £100,000, as you have £50,000 in your savings account. This can reduce your mortgage cost by effectively using your savings.

What are the pros and cons of offset mortgages?

While an offset mortgage can seem attractive, there are disadvantages.

Pros

  • Pay your mortgage off early – You can use the savings you make on paying less interest towards paying off your mortgage early. This can be much cheaper than a repayment mortgage across the term.
  • Save money on tax – If your savings are in an offset account, you can benefit from the return offset against your mortgage without paying tax.
  • Get more from your savings – If the interest rate on your savings account is less than your mortgage rate, you could put your savings to better use with an offset mortgage.

Cons

  • Higher interest rates – When compared to repayment mortgages, interest rates tend to be higher, but it may still work out cheaper overall.
  • Only recommended with adequate savings – Spending money in your offset account may make your mortgage more expensive. This is because you’ll have less capital to offset. An offset mortgage is only advised if you can leave your savings untouched for most of your mortgage term.
  • Unable to access your savings – Some lenders also cap what can be withdrawn. As a result, you may be unable to access your savings when needed, which can cause financial problems. If your mortgage deal requires a minimum savings balance, check with your lender beforehand.
  • Less choice – Compared to repayment mortgages, fewer lenders offer offset mortgages. As a result, you could find yourself with little choice. Furthermore, when lenders have less competition, mortgage rates tend to be slightly higher.

Offset mortgage rates

It’s common for offset mortgage rates to be slightly higher than regular mortgages. After all, you’ll use your savings to minimise your balance, so a slightly higher rate can be justified. Furthermore, you’re still likely to save money on your mortgage each month.

Even with little savings, a small amount can still reduce your monthly payments. Small savings each month can accumulate to large savings when calculating the overall cost of your mortgage.

Many offset mortgage lenders allow borrowers to add to their savings accounts or withdraw funds when needed. If you withdraw funds, your mortgage payments will increase. In comparison, adding funds to your savings account will reduce your payments further. This is because you can offset more of your mortgage with more savings.

Some mortgage deals may allow you to make overpayments. That said, adding additional funds to your savings account is often more viable. Although an overpayment will bring your mortgage balance down, additional savings will have the same effect. The only difference is that you’d still be able to access your savings. Once you make an overpayment, the funds are irretrievable unless you remortgage and release equity.

You can view current offset mortgage rates here.

Calculating how to save the most on your mortgage

Whether you choose an offset or a regular mortgage, it’s worth calculating the costs involved before deciding. Savings aren’t likely to give you the benefit they could.

An advantage of an offset mortgage is that you’d save more interest on your mortgage than you’d gain in a savings account. Furthermore, you may be liable to pay tax on any interest you make from your savings. In comparison, you’d pay no tax by offsetting your mortgage against your savings.

On the other hand, earning zero interest on your savings can be seen as a disadvantage. This is why it’s important to calculate which deals will save you the most money each month.

Offsetting your mortgage can allow you to use your savings as security for a mortgage deposit for a child or family member. This can be great for when you don’t want to gift a mortgage deposit but would consider being a guarantor instead. Once part of the mortgage is repaid, lenders typically allow guarantors to access their savings as they no longer need security for the loan.

How mortgage advisors can help

We understand that calculating and comparing mortgages can be difficult. This is especially true when comparing hundreds of lenders. Furthermore, trying to assess whether an offset mortgage would save you more money than a regular mortgage isn’t an easy task.

Mortgage advisors can calculate each deal with the lenders you’re eligible for. We’ll also compare whether an offset mortgage would be better suited than a regular deal. In doing so, you can calculate which deal will save you the most each month.

You’ll also have to consider the costs and fees involved with certain mortgages. Although you may think a lower mortgage rate will save you more money, fees can impact the overall cost of your mortgage. This is why speaking to an advisor can be so beneficial.

About the author

Martin Alexander
Senior Mortgage Advisor

Martin is a senior mortgage advisor who has held a CeMAP qualification for over 15 years while completing an MBA in Global Banking and Finance.