What is an Offset Mortgage?

Written by Daily Fix - Published 27-Jun-2023, last updated 08-Aug-2024

Let's get straight to it. An offset mortgage is a type of mortgage that allows you to link your savings account or current account to your mortgage. The value of your savings or current account balance is then deducted from your mortgage balance, so you pay interest on the balance. This lowers your monthly payments.

For example, if you have a mortgage balance of £100,000 and £20,000 in savings, you will only be charged interest on £80,000. This saving can be used to lower your monthly payments or shorten your mortgage term.

But let's look at offset mortgages in more detail.

Important notice: This information is general in nature and not intended to be financial advice. You should consider your own circumstances in deciding whether an offset mortgage is right for you, and it's a good idea to seek professional advice from your bank or an independent mortgage broker.

How do offset mortgages work?

Offset mortgages work by linking your mortgage to a special savings account or your current account. The money in your offset mortgage account is not used to pay off your mortgage, but instead it is used to reduce the amount of interest you pay.

When you make a payment into your savings account, the amount of your mortgage balance that is offset will increase. When you make a withdrawal from your savings account, the amount of your mortgage balance that is offset will decrease.

You will only pay interest on the balance of your mortgage, minus the amount that is offset by your savings, thus reducing the amout of mortgage interest you pay.

Who might offset mortgages be good for?

Offset mortgages may be a good option for people who have significant amounts of savings as these savings can be "offset" against to mortgage so that your mortgage interest is reduced. The interest rates paid on savings are usually less than the interest rates paid on mortgages, therefore it makes sense save more interest on your mortgage payments than you would receive on the money if it was in a savings account.

It isn't always the case that savings interest rates are less than mortgage interest rates. You may be on a fixed rate mortgage that was started in a time of low interest rates, since which the Bank of England Base Rate has increased along with savings interest rates.

So you should check your exisitng mortgage product and compare it against rates you are currently getting on your savings to see if an offset mortgage may be a better option.

If you are self-employed or have an irregular income then you might benefit from an offset mortgage because you can add money to your offset savings acocunt when you have surplus income or receive a lump sum (for instance, a dividend payment) and then draw on those savings when and if you need to as the savings are still yours to access. And all the time that money is in your savings account it is reducing your mortgage interest payments.

Finally, there can be tax advantages to having an offset mortgage as you won't pay tax on any interest earned on your savings. This is because the money in your savings account is not actually earning interest, it is simply being used to reduce the amount of interest you pay on your mortgage. You will still get a return on your savings, but it is in the form of reduced mortgage interest charges, rather than the amount of interest earned on your savings accounts. Plus, the money in your savings account is still there and can be accessed if you need it.

What are the pros of offset mortgages?

Here are some of the pros and key benefits of an offset mortgage:

• Offset mortgages can save you money on your mortgage repayments by reducing the amount of the mortgage interest charged.
• Offset mortgages usually give you instant access to your savings at any time.
• Offset mortgages can help you shorten your mortgage term as you can use the interest saved on the mortgage to overpay the capital.

What are the cons of offset mortgages?

Here are some of the cons and disavantages of offset mortgages:

• Offset mortgages are not available from all lenders.
• You will not earn interest on the savings offset against your mortgage balance which you may rely on to top up your income. Are you happy receiving less interest?
• You may have to pay an arrangement fee or a product fee which is higher than the typical arrangement fee charged on a "traditional" mortgage loan.

Conclusion: Might an offset mortgage be for you?

If you're considering an offset mortgage, it's important to compare different deals and the latest rates to find one that's right for you before you start your mortgage application. You can use one of the many offset mortgage calculators to compare various scenarios.

Using large amounts of savings to offset your mortgage balance could save you a lot in mortgage interest payments, but this is at the expense of the interest you would receive on those savings if they were tucked away in a savings account.

So consider your individual circumstances, the interest you are receiving on your savings and the offset mortgage interest rate to see whether or not an offset mortgage is the best option for you, or whether you would be better off with a standard repayment mortgage while your savings earn interest elsewhere.