Save with an Offset Mortgage
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.
What is an Offset Mortgage?
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.
How to Pay off Your Mortgage Quicker
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:
- Offsetting a lump sum against your mortgage means you’ll pay interest on a lower amount of money.
- Keeping your monthly mortgage payments the same means you’ll effectively be overpaying on your mortgage each month.
- The mortgage balance reduces faster, which means you pay off your mortgage early.
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.
How to Reduce Your Monthly Payments
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.
The Different Types of Offset Mortgage
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.
Current Account Mortgages (CAM)
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.
The Tax Benefits of Offsetting
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.
Who Are Offset Mortgages Suitable For?
- Anyone with savings or who might be able to overpay either a monthly amount or a lump sum.
- The self-employed who might get paid more some months than others, or who save large sums of money for their tax bill which they need easy access to.
- Workers that receive regular or annual bonuses.
- Higher-rate taxpayers.
Things to Watch Out For
- The main disadvantage of offset mortgages is that you won’t earn any interest on your savings. However, as explained above, you’ll be saving more money than you would have earned in interest anyway.
- When offset mortgages were first introduced they were significantly more expensive than mainstream mortgage deals. But these days rates are about the same on offset and non-offset deals. However, if you specifically want an offset mortgage you might find it’s not the most competitive deal available. If you don’t have much in the way of savings, finding the cheapest possible mortgage might save you more money.
- If you have a large savings pot it might make better financial sense to use it as a deposit to lower your loan-to-value (LTV), making you eligible for the best mortgage deals, rather than offsetting it. Bear in mind, however, that once you’ve put the money down as a deposit you’ll no longer have access to it.
- If you need to borrow a high percentage of your property’s value you might find it hard to get a decent offset deal. The best offset mortgages tend to require a LTV of 75% or less.
- Before choosing any mortgage it’s vital to look at the product overall, not just its offset ability. This includes arrangement and other fees, the interest rate, the length of any fixed period and early repayment charges.
What Happens if Your Mortgage Lender Goes Bust?
- Under the Financial Services Compensation Scheme (FSCS) your savings are protected up to £85,000 per bank or building society, even if they are in an account linked to a mortgage. However, any money you have in your offset account above the £85,000 FSCS limit will be used to pay off your mortgage if the lender goes bust. For example, someone with a mortgage of £400,000 and savings of £100,000 would receive £85,000 from the FSCS, and would have their mortgage debt reduced by £15,000 to £385,000.
- The one exception is a current account mortgage where the mortgage, savings and current account are all held together by the lender. The FSCS treats this as a single account. If the lender went bust the customer would lose access to their savings as the cash would be used to pay down the mortgage. In the above example, a customer would get nothing from the FSCS but the mortgage debt would be reduced to £300,000.
The Golden Rules of Offset Mortgages
- Shop around for the best offset deal.
- Decide what’s most important to you when offsetting; reducing your mortgage term or lowering your monthly repayments.
- Remember to use the offset facility wherever possible.
- Don’t get caught out by confusing offset and flexible mortgages.
- Don’t borrow money to make overpayments - unless it’s at a cheaper rate than your mortgage.