Offset mortgages: what are they and how do they work?

Offset mortgages can be a smart way to minimise the interest you pay over the term of your loan, but they don’t suit everyone.

Here are the key facts you need to know about offset mortgages and how they may (or may not) save you money.  

What is an offset mortgage? 

An offset mortgage is a property loan linked to a savings account.

The money you have saved in the account is used to reduce the total balance you pay interest on each month. 

It’s not an interest-only mortgage (where you would only pay the monthly interest amount).

With an offset mortgage, you will make monthly repayments to bring down the outstanding balance. But the total amount on which interest is calculated takes the linked savings you have into account. 

How does an offset mortgage work?

It is easier to explain how offset mortgages work if we first consider how a typical mortgage works.

In this scenario, you borrow a lump sum and make monthly payments to repay the loan. Added to the monthly payments is interest, which is calculated on the entire balance.  

With an offset mortgage, on the other hand, the amount you have in savings will be treated as credit on your mortgage, or like an overpayment. It is used to reduce — or offset — the balance that interest is paid on. 

Let’s look at that in numbers. Say your mortgage is £150,000 and you have £50,000 in a linked savings account. You would only pay interest on £100,000 — the full balance minus the amount you have in savings. 

What is important to remember is that your savings are only used to offset the remaining balance for interest purposes. You will still need to pay off the loan in full. 

What are the benefits of an offset mortgage? 

The obvious advantage of an offset mortgage is that you can minimise the interest you pay.

As long as you have a decent amount in the savings account, you’ll be paying interest on a smaller figure.  

Going for an offset mortgage means you may be able to put down a smaller deposit.

So, if you don’t want to tie up all your savings in property, you could still access them — though any money you take out of the account will no longer offset the loan amount. 

There’s also a tax benefit. You won’t pay tax on the savings (because they don’t earn interest), which means they won’t be counted towards your Personal Savings Allowance. Although they won’t earn interest, they will be helping you save interest elsewhere. 

What are the disadvantages of offset mortgages?

Offset mortgages aren’t the guaranteed interest saver you may expect them to be. They do carry higher rates, which might mean you don’t end up saving much through the offsetting element.

By putting the cash into the property on the other hand, you will have a lower loan-to-value ratio, and this can help you access the better deals. 

As mentioned, you won’t earn interest on the savings in your account, so it’s important that the amount of interest you’re saving outweighs the amount you could earn in a different account.

You’ll also need the linked savings account to be with the same provider, which can mean you need to switch accounts if you remortgage with a different lender. 

There are fewer offset mortgages around, so your available deals may be limited. You may also have to pay high fees, which could counteract potential savings. 

What are the different types of offset mortgage? 

There are a few main products to suit different borrowers.

These are: 

Family offset mortgage 

These mortgages are designed for those who want to help family members get on the property ladder.

For example, if it’s a parent, they would have a savings account linked to their child’s mortgage account, which could be used to bring down the mortgage interest.

Setting up this kind of arrangement can help first-time buyers get accepted by lenders. 

Buy-to-let offset mortgage 

Landlords can use buy-to-let offset mortgages to minimise their monthly payments and increase their profit margins. 

Should I take out an offset mortgage? 

Offset mortgages are generally designed for people with big savings that they won’t need to dip into for a number of years.

They work well for these situations: 

• Family members who want to help children or other family members get on the property ladder but do not want cash tied up in the property 
• People who want to access to cash, for example, for renovations 
• Higher rate taxpayers who want to avoid paying the 40 to 45 per cent tax rate on savings interest 

Whether or not you should take one out will depend on how much flexibility you want for your cash and the amount the arrangement could save (or lose) for you.

That’s why it’s always important to do the sums on the interest. 

Is it better to put down the cash as a deposit? 

Putting down a bigger amount as a deposit will help you access better deals. But keeping the cash in a linked account will mean you pay interest on a smaller amount.

You need to calculate the interest in both scenarios to decide which is most cost effective.  

Generally speaking, you would need at least 20 to 25 per cent of the mortgage amount to remain in savings for an offset mortgage to be worthwhile.

But don’t just take our word for it — do the sums or speak to a mortgage broker. 

Is it better to overpay or get an offset mortgage? 

An offset mortgage is a bit like overpaying. However, when you overpay, you will have to factor in the cost of early repayment fees (if you pay over the limit) and accept that you no longer have access to the cash.

With an offset mortgage, however, there is no limit as to how much you can keep in your linked account to offset the interest. But the downside is that you will usually pay higher interest and fees to have the mortgage. 

There is a lot to consider when it comes to choosing the right mortgage for you.

As well as calculating all the sums, a mortgage adviser can help you decide whether it is more practical for you to keep access to your cash with an offset mortgage.

For a clearer picture of your options, speak to an adviser through the Unbiased network.  

Getting the right financial advice for your circumstances is key. Find your perfect financial adviser now.