Offset mortgages let you utilise your savings by offsetting the balance from savings against your mortgage debt, which saves you interest.
Lenders that provide offset mortgages can be few and far between but if you can qualify for this type of loan, you may be able to save money in the long run vs if you’d have taken out a standard residential mortgage.
What is an offset mortgage?This type of mortgage product allows the homeowner to offset the amount they owe on their mortgage against any savings they have to either reduce the term of their mortgage or the amount they have to pay each month.
This is different from the majority of other mortgages which are charged with interest based on the total amount borrowed.
How do offset mortgages work?Interest rates are low, with the current BoE base rate set at 0.1% at the time of writing. An offset mortgage can be taken out by an eligible borrower that has a mortgage deposit, as well as additional savings.
The savings are linked to the mortgage but don’t repay it - they just remain in an account and are used to offset the mortgage balance, meaning that you only pay interest on the mortgage balance minus your savings.
Your money is still accessible, though each offset mortgage lender will have their terms and conditions with varying degrees of flexibility, so always check your contract and ideally, have a solicitor and a mortgage broker look through your agreement.
An offset mortgage broker can highlight any terms that might cause concern later down the line if you want to access your money quickly and can help you to avoid the lenders with high penalty fees if any.
Offset mortgage exampleYou might have a £200,000 mortgage debt but have savings of £20,000. The £20,000 doesn’t reduce your overall mortgage debt but you only pay interest on the total of your mortgage debt minus the total of your savings balance.
That saving can be used to lower your monthly payments or shorten your mortgage term.
Payment reduction offset mortgages vs term reduction offset mortgage
When you apply for an offset mortgage, you’ll need to choose between two options that affect how you repay your loan.
A payment reduction offset mortgage might be better if you want lower monthly repayments whereas a term reduction mortgage might be the route for you if you’re hoping to pay off your mortgage early.
Payment reductionYou can ask your chosen lender to use the interest you save to reduce the amount you have to pay each month over the term you’ve agreed in your mortgage offer letter.
If you choose payment reduction, the interest you save in one month from offsetting your savings, reduces your next month’s mortgage repayment, and so on.
Term reductionYour savings help reduce the length of your mortgage by offsetting your mortgage balance and reducing the amount of interest charged.
If you choose term reduction your monthly mortgage interest repayments will stay the same but you could end up paying fewer of them.
Why would I get an offset mortgage?
- If you’ve got money sitting in a savings account but not making much interest, that cash could be used to offset mortgage debt instead.
- If you had kept your savings in an account not linked to your mortgage, the interest made on those savings would likely be less than the savings earned with an offset mortgage.
- Interest earned on a standard savings account is taxable but savings made from paying less on your mortgage aren’t
Can I access my savings quickly if I need to with an offset mortgage?Yes. Offsetting your savings against your mortgage is not the same as overpaying and you can get your savings back anytime you need them.
Keep in mind that if you choose to withdraw money from your linked savings account, your repayment amount or term time will increase because the proportion of mortgage debt you have that is charged with interest increases.
What rates do I get with an offset mortgage?
Interest rates vary for offset mortgages and while one applicant might be offered an agreement with 4% interest, another with different circumstances and a lower loan to value could be offered a rate of 2%.
Mortgage lenders will judge your affordability and ability to repay the amount of mortgage you’ve applied to borrow, usually by looking at factors like your debt-to-income ratio, credit history, and dependency of income.
If your circumstances present a risk of defaulting (missing a mortgage repayment), you’ll likely be rejected for a mortgage or be charged a higher rate of interest.
The rate of interest you’re charged can also be affected by:
- Your deposit size
- The amount of savings you have to offset
- Whether your mortgage agreement has a fixed or variable rate of interest
How much money can I save with an offset mortgage?
That will depend on how much your mortgage is, the rate of interest you’re charged and the amount of savings you have but as an example, say you have a £200,000 mortgage and you’re charged 3% interest.
You have £30,000 in savings so the total amount you pay interest on is reduced to £170,000. Over a year, that interest would cost you £5,100 whereas if you had paid interest on your total mortgage debt of £200,000 you would pay £6,000 of interest a year.
The £900 difference is a saving in itself but let’s compare it to the potential savings made if you had left your savings in a standard savings account and hadn’t offset them against your mortgage.
Interest rates for savings accounts typically follow the Bank of England Base Rate (currently 0.10%), but if hypothetically, let’s say you could have left your savings in an account earning 2% interest.
You would have earned £600; £300 less than the figure saved by offsetting your mortgage to reduce the amount of mortgage you’re charged interest for.
Are offset mortgages tax efficient?
Offset mortgages don’t earn you any interest - they save you money by offsetting your mortgage debt against your savings balance.
If you earn money in a savings account other than a tax-free ISA, you’ll be required to pay income tax on the interest you receive which could be up to a startling 40% if you’re in the higher tax rate band.
People paying the basic rate of income tax would be required to pay 20% of their earnings from their savings, whereas if you use your savings to offset against your mortgage, there is no tax to pay on the resulting savings.
An offset mortgage, therefore, does not affect your Personal Savings Allowance and you won’t be required to pay tax on the savings made through offsetting your mortgage.
Advantages of offset mortgages
- The interest saved will likely be greater than the amount that can be earned from a savings account in 2021.
- Some lenders let eligible borrowers link multiple savings accounts, including ISAs.
- Provides the option to reduce mortgage debt quicker or to alternatively, repay less each month.
- Some types of offset mortgages let the borrower offset their mortgage debt against a family member’s savings, which could be handy for those unable to save a large deposit or without savings of their own to offset.
- There are tax advantages - offset mortgages save the borrower money as opposed to earning them interest so income tax isn’t payable.
Disadvantages of offset mortgages
- Mortgage rates can be higher for offset mortgages.
- Interest isn’t earned with an offset mortgage, it’s saved.
- If the borrower makes a withdrawal, payments on the mortgage may increase in line with the proportion of the savings that have been withdrawn.
- The Loan to Value (LTV) ratio available can be lower for offset mortgages compared with standard residential mortgages.
- Subsequently, the deposit requirements are higher and some borrowers may need a 25% deposit.
- Some lenders prefer the savings and mortgage account to be from the same provider or bank.
Should I put down a bigger deposit rather than offsetting?If you’re happy to have more of your money tied up in your property as opposed to being in a savings account that allows you to access your money quickly, you could consider putting down a larger deposit.
Putting down a larger proportion of a property’s market value reduces your mortgage, so you have less debt and pay less interest vs if you had taken out a mortgage with a lower deposit.
Being in a position to own more equity upfront may also result in you being offered lower interest rates by lenders.
Are offset mortgages good for self-employed people?Potentially yes. Some self-employed workers and contractors save money in a savings account for their tax bills to earn interest and set aside a pot to cover their tax payment for the year.
The problem with this is that some savings accounts can have restrictions on how many times money can be withdrawn within a certain time frame and some charge drawdown fees.
In contrast, most offset mortgages give borrowers the ability to access their money when they like, so by linking their mortgage to an offset savings account, they get the benefit of saving money without restrictions like how many times they can access it.
Can I get a buy-to-let offset mortgage?Buy-to-let mortgages are available with offset agreements and landlords may be able to benefit from savings on interest.
Landlords haven’t been able to deduct interest payments on their tax bills since 2017, so buy-to-let investors utilise offset mortgages to reduce the overall cost of their mortgages.
Buy-to-let offset mortgages can typically come with higher deposit requirements, so be prepared to have at least 25% of the property’s market value or more, depending on your circumstances.
Ask a specialist buy-to-let broker to look at your circumstances and use your plans for future property investment to help you acquire the right mortgage, with the right level of flexibility, now.
Take your time and get advice from an offset mortgage expertAn offset mortgage broker will ask for some information so that they can provide you with accurate advice that’s relevant to your situation. This will include details about your income, your credit report, a copy of your passport or driver’s license, and details about your deposit.
They can calculate how much you could save by getting an offset mortgage and work out the maximum amount you could afford to borrow.
If you’re eligible for an offset mortgage and a suitable lender is found that can provide you with the finance and flexible terms you need, and you’re approved, you’ll get an Agreement in Principle (AIP) or mortgage promise.
This is like an agreement between you and your lender that tells you the amount of money they’re prepared to lend you, under the circumstances in which you applied.
Then you can search for properties knowing your budget and with the confidence that you have a willing lender.
Can I pay my mortgage off quicker with an offset account?Yes. Your mortgage repayments are based on your total mortgage debt while the interest you’re charged for an offset mortgage is based on your mortgage debt minus your balance from your savings.
That means that technically you’d be overpaying your mortgage so you could pay it off quicker.
Can an offset account reduce monthly repayments?Alternatively, you could use the savings to reduce your monthly bill, though this wouldn’t affect the duration of your term.
Can I get an offset remortgage?Check your eligibility with a qualified and reviewed mortgage broker before applying for an offset mortgage - that way you’ll know the likelihood of you getting approved, how much money you can borrow, and how many lender products you have to choose from.
How much savings do you need for an offset mortgage?There’s not usually a minimum amount of savings required for an offset mortgage but the more money you have in your account, the less interest you pay for your mortgage.
Once your mortgage is agreed upon and set up, your chosen lender will open an offset saving account for you to transfer funds into.