Guide to offset mortgages
- With offset accounts savings don’t earn interest, but instead reduce interest paid on a mortgage balance
- Can be a flexible and tax efficient option
- You may need significant savings to make offsetting worthwhile
- Deposits, interest rates and fees tend to be higher than on other mortgages
- For expert, fee-free mortgage advice, you can request a call back from London & Country or phone 0800-073-1959
Offset mortgages are flexible products, designed for people who want to hang onto and build their savings as they repay their mortgage.
How does an offset mortgage work?
An offset mortgage links your savings to your mortgage or, more accurately, offsets the value of your savings against your mortgage.
Instead of earning interest on your savings, you pay less interest on your mortgage.
So, for example, if you take a mortgage for £150,000 but you have £30,000 of savings, with an offset mortgage you would earn no interest on your savings but would only pay interest on £120,000 of the mortgage.
Effectively, you're saving your money tax free at your mortgage interest rate. So if your offset mortgage rate is 5%, it's like having a 5% tax-free interest rate on your savings.
However, offset mortgages tend to have higher fees and to charge a higher rate of interest than standard mortgages, so you need to take these into account too.
Who are offset mortgages for?
Offset mortgages are typically aimed at buyers with large savings and those who pay a higher rate of tax.
Income tax would usually be payable on savings interest, but with an offset mortgage there's no interest earned, which means there's no tax to pay.
Offsetting can still be worthwhile, however, for those in a lower tax band, as they also receive some tax relief.
This type of mortgage can also be useful for the self-employed, as they can make the most of the money they put aside for the taxman before they have to hand it over.
Advantages of offset mortgages
With an offset mortgage you retain access to your savings, so it's a more flexible option than using your savings to pay off a portion of your mortgage.
Did you know...?
- Offset mortgages are typically linked to a savings account, but you can also find products that use a current account or Individual Savings Account (Isa) for offsetting
Offsetting can also be tax efficient. You would ordinarily pay income tax on any interest you earn on savings, but if you offset your savings you have no tax to pay.
With some providers you can also link your current account to your mortgage, and sometimes even a Cash Isa, though this is rare. The more savings you link to your mortgage, the more you can reduce your debt.
Offset mortgages are usually very flexible, allowing you to make underpayments and overpayments. Again, this can make them a practical option for self-employed people without a fixed income.
Disadvantages of offset mortgages
At the time this article was originally researched (December 2014), only a handful of providers allowed customers to include their current account balance in the amount offset against their mortgage, and even fewer allowed an Isa balance to be used.
The effective return on cash savings by offsetting will generally beat what's available on standard savings rates
Adam Jones, London & Country
It's important to be aware that if you remove any money from your savings, there'll be less to offset against the mortgage and it'll take longer to repay.
To get an offset mortgage your savings and mortgage have to be with the same provider.
This could limit you from shopping around for savings and current account products that better meet your needs.
Also, unless you find a provider offering an Isa-linked offset mortgage, removing money from your Isa to offset against your mortgage means your savings will lose their tax-free status.
Most offset products require a deposit of at least 25%, so they aren't ideal for first-time buyers struggling to save up a deposit.
Offsetting with an Isa
Although it's not something offered by many providers, you might think it strange that anyone would want to use an Isa to offset their mortgage.
However, you can only save a certain amount a year into a Cash Isa, so if you continue to build your Isa balance each year while it's being used to offset your mortgage, you'll eventually be able to transfer a large lump sum to a non-offset Isa account where it'll earn interest tax-free.
It's an attractive prospect, but offset mortgages linked to Isas are a rarity at present - and your savings will lose their tax-free status if you remove them from your Isa to put in your offset pot.
"The effective return on cash savings by offsetting will generally beat what's available on standard savings rates, particularly for higher-rate tax payers," said mortgage broker London & Country's Adam Jones.
"However, very few offer products which allow you to offset a Cash Isa and it's important to consider that withdrawing money from an existing Isa to offset would mean the loss of that Isa allowance built up over previous years."
Do mortgage advisers recommend offset mortgages?
"Offset mortgages are something customers should consider when looking at types of mortgage products, especially if they have a large amount of savings or big credit balance in their current account," said Jones.
"An offset mortgage can come in handy if you're planning home improvements that will take some time to complete.
"You can agree the borrowing up front then draw money from the offset account as and when you need it, without incurring interest on the entire lump sum from day one.
"However, offset deals will usually carry a higher rate than more traditional products, so it's important to work out if you'll make enough use of the offset functionality to make up for the higher rate.
"If you don't have a reasonable proportion of your mortgage balance in savings, an offset may not work out as the best option for you."
By Emily Bater