What is an offset mortgage?
An offset mortgage is a way of linking your mortgage with your cash savings and sometimes your current account too.
With this type of mortgage, credit balances are offset against the outstanding mortgage balance and interest is only charged on the remainder.
For example, if you have a mortgage of £200,000 and use your savings of £20,000 to offset it, you will only be charged interest on the net balance of £180,000.
Although you won’t earn interest on the savings used to offset your mortgage, you’ll still be quids in as we tend to receive less interest on our credit balances than we pay on our debts.
How do they work?
An offset mortgage reduces the amount of interest you pay on your mortgage debt, and so saves you money.
Most banks have two offset mortgage options, allowing you to either:
- reduce the term of your mortgage
- reduce your monthly payments
The quicker you pay off your mortgage, the lower your overall interest bill.
But lower monthly payments can make household budgeting easier, especially in the cost-of-living crisis.
These types of mortgages tend to be flexible and usually allow you to make overpayments on your mortgage, and sometimes the ability to make underpayments if overpayments have been made in the past.
What are the pros?
- You’ll usually save more on the interest on your mortgage than your money would earn in a savings account.
- The lower interest charges mean you can either pay the same amount each month and clear your mortgage quicker, or lower your monthly payments.
- You’ll pay zero tax on the interest you save, meaning offset mortgages are tax efficient for higher and additional rate taxpayers.
- You can still access the money in your savings account if you need it.
What are the cons?
- Interest rates on offset mortgages tend to be higher than the best buys available on standard mortgages.
- You won’t earn interest on any cash held in savings accounts linked to the mortgage.
- There is a limited choice of offset mortgages.
- You won’t save a lot of money with an offset mortgage unless you have a decent amount of cash savings.
- Depending on the interest rate, you may be better off using the savings you would have put into a linked savings account to pay down the mortgage itself.
Would I be better off overpaying my existing mortgage or switching to an offset mortgage?
Not all mortgages allow overpayments. Of those that do, some mortgage products limit overpayments to 10% of the outstanding balance each year. If you overpay more than that, early repayment charges will apply.
So, whether you would be better off overpaying your existing mortgage instead of switching to an offset, depends on your mortgage terms. If you are still locked into a fixed rate, or ERCs apply to overpayments, fees and charges could negate any savings you make by switching to an offset.
How does an offset mortgage work on a monthly basis?
Each month your mortgage lender will work out how much you need to pay in order to repay your mortgage at the end of the term.
If your aim is to repay the mortgage quicker, offsetting won’t have an impact on your monthly mortgage payments. But the interest you save by offsetting your savings means your mortgage balance will reduce faster, and you will be able to pay your mortgage off early.
If you choose to reduce your payments, your offset savings will mean lower monthly payments, but you won’t pay off your mortgage any sooner. The more savings you offset, the lower your monthly payment will be.
What are lenders’ criteria for an offset mortgage?
As with any mortgage, you’ll need to meet the individual lender’s criteria for an offset mortgage. This means you will need to pass the affordability assessment and credit checks.
You’ll also need to have money to put in a savings or current account with the same lender.
The lender will also look at your income to assess whether you can afford the usual monthly mortgage payments.
Is an offset mortgage a good idea?
They can be a good idea if you have a significant amount of money to offset against the mortgage loan.
If you only have a low amount of savings, you’d probably be better off looking for the cheapest interest rate/mortgage fees combination you can find. A mortgage broker can help you find the best deal.
Always remember that your property may be repossessed if you do not keep up repayments on your mortgage.
Individual savings may vary, your savings will depend on personal circumstances
Last Updated: March 21st, 2023