Offset mortgages are a great way to shave years off the length of your mortgage. By simply using your savings to reduce the amount of interest you pay on your mortgage you can reduce the overall cost by tens of thousands of pounds.These really are the lesser-known gems of the mortgage world. So, read on to find out exactly how an offset mortgage can make you some of the biggest financial savings of your life.
An offset mortgage uses your savings to reduce the interest you pay on your mortgage. So, you put your savings into an account that is linked to your mortgage and the balance of your savings account is ‘offset’ against your mortgage. As a result, you pay less interest which can save you thousands of pounds over the term of your mortgage.
For example, if you had a £100,000 mortgage and put £20,000 of savings into a linked account, you’d only pay interest on £80,000 of your mortgage debt. You won’t earn any interest on your savings, but the amount of money you will save in interest should outweigh the loss. If your mortgage rate is 4% you would need to be earning at least 5% (before tax) on your savings to beat the cost of your mortgage.
Crucially, offsetting your savings against your mortgage is not the same as overpaying; with offsetting you can get your savings back any time you need them.
Offsetting means you can knock years off your mortgage, so you’ll own your home outright much quicker than you originally planned.
Here’s how it works:
For example, if you had a £100,000 mortgage at 3% you’d pay £474.21 a month on a repayment basis over a 25-year term. If you offset £20,000 of savings and kept your monthly payments the same, you’d pay off your mortgage seven years earlier saving over £17,000 in the process.
Offsetting can also mean you can benefit from lower monthly payments. Once you’ve offset your savings your mortgage repayments will be automatically adjusted to reflect the smaller interest bill. You can overpay (see above) or simply enjoy the lower monthly repayments – although that means you won’t pay off your mortgage any quicker.
For example, if you offset £20,000 of savings against a £100,000 mortgage your monthly payments would fall by £95 a month and your total interest bill would be reduced by almost £28,500.
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This is the most common option where you have a savings account linked to your mortgage. The balance of the account is calculated daily and you pay interest only on the leftover mortgage balance.
This is the same as a standard offset account, except that your current account is also linked to your mortgage so your current account balance is included in offset calculations.
These are harder to find but enable your family members to put their savings in an offset account that only they have access to but benefits another family member’s mortgage.
These are similar to offset mortgages but with crucial differences. If you have a flexible mortgage you can make overpayments, either via a lump sum or monthly, up to specified maximum amounts.
You can later ‘borrow back’ the money when you need it or take payment holidays. However, the ‘borrowing back’ and payment holiday facilities are at the lender’s discretion and there have been instances where lenders have turned down borrowers’ requests.
Offset mortgages, on the other hand, keep the mortgage and savings in separate – yet linked – accounts, meaning the customer can access their savings whenever they need to without having to get permission from the bank.
Offset mortgages are a really good way of reducing your tax bill. If you have money in a savings account you’ll pay income tax on the interest you receive (unless the money is in an ISA). This means you could be parting with up to 40% of your interest.
But if use your savings to offset against your mortgage, there is no tax to pay on the resulting savings. For example, if you had £20,000 in a savings account paying 2.5% you’d earn £500 interest a year before tax. But, basic rate tax payers would pay £100 of that to the taxman and higher rate tax payers would lose £200.
With an offset mortgage you give up the opportunity to earn interest on your savings, but the equivalent return you get in terms of shaving interest off your mortgage is tax-free. So if you put that £20,000 into an offset account against a £100,000 mortgage with a 3% interest rate you would knock £17,000 off your mortgage interest bill, and pay no tax on that saving.