Many homeowners are considering using their savings to overpay on their home loan – paying off some of their debt to try and reduce monthly repayments.
However, not everyone wants to part with their savings. That’s where an offset mortgage may offer a lifeline. An offset mortgage gives you the opportunity to use your savings to reduce the amount of interest you pay on your mortgage – without having to part with your money.
“When mortgage rates are higher and as savings rates aren’t always competitive, offset mortgages start to look increasingly attractive,” says Mark Harris, chief executive of mortgage broker SPF Private Clients. “Although offsets are priced at a premium to standard deals, they will come down in line with the general trend for lower rates.
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“The added advantage of an offset is that your savings work harder to reduce the interest you pay on your mortgage, so with savings rates also falling, it might make sense to offset any savings against your mortgage rather than put them in a standalone savings account in a falling interest rate environment.”
How does an offset mortgage work?
If you get an offset mortgage, you open a savings account that is linked to your mortgage. Money that you put in the savings account won’t earn interest, but the balance will be deducted from what you owe on your mortgage when the interest for your debt is calculated.
So your savings reduce the interest owed on your mortgage.
With most offset mortgages you then have a choice on how you use those savings. You could opt to reduce your mortgage payments each month, or you could opt for higher monthly repayments, but use what you are saving in interest payments to shorten the overall term of your mortgage – meaning you clear your debt sooner.
For example, let’s say you have a £250,000 mortgage, and £50,000 in savings on a five-year fixed offset mortgage at a rate of 4.85%. According to calculations by SPF Private Clients, if you put your savings in the linked account over five years you would save £12,052 in interest.
Advantages of an offset mortgage
With an offset mortgage, you have the opportunity to make bigger savings on mortgage interest payments than the interest you would earn with a savings account.
Offset mortgages are flexible which means you still have access to your savings if you need to make a withdrawal at any time. This flexibility means you can access your savings balance without having to remortgage to raise funds.
It is possible to add multiple savings accounts and even ISAs to your offset mortgage to maximise the interest saving you can make, though this option varies between lenders.
There’s also a potential to save on your tax bill when using savings to offset your mortgage. While savings interest is subject to income tax, there’s no tax to pay on the interest saved on using your savings to reduce your mortgage interest.
Offset loans might be attractive if you are self-employed, as keeping money set aside for tax bills in an offset account can help make savings in advance of the self-assessment payment deadline.
Disadvantages of an offset mortgage
An offset mortgage won’t always save you money. In the above example, I’ve assumed that you don’t need to access any of your savings for the full five years.
You can withdraw your money whenever you like, but when you do, you’ll pay more interest on your mortgage. If you know you won’t need your money for five years, you might be better off going for a standard fixed-rate mortgage and putting your savings into a top-paying five-year bond.
It is also worth running the sums to see if using some of your savings to reduce your mortgage debt would put you into a different loan-to-value (LTV) bracket.
The lowest LTV threshold for the vast majority of lenders is 60% for which the most competitive rates are reserved. So if your LTV was just above that, you might be better off using savings to pay off some of the mortgage to benefit from a reduced rate of interest and could save far more than an offset mortgage.
David Hollingworth of London & Country Mortgages reckons offsets make sense for those with 5%-10% of their mortgage balance in savings or those who receive regular large bonuses but may need access to the money.
"Because most of us have a much bigger mortgage than savings balance, if you can knock 0.5% or even 1% off the interest rate by choosing a standard loan, you should."
Can you still pay in and withdraw savings with an offset mortgage?
Offset mortgages are usually completely flexible which means that you can withdraw and pay in savings as and when you need to raise funds or have some spare cash to stash.
The more you add to your savings pot, the further you will reduce the mortgage debt that you have to pay interest on.
Withdrawing funds means that your interest charges will be higher.
The way lenders apply interest charges works differently between lenders. Some offset mortgage providers may keep your monthly payments the same even if you have paid in extra cash into your offset account. In this case, more of your monthly payment goes towards paying off the mortgage balance, rather than going to the lender as interest. This can help you to pay your mortgage off quicker.
Other lenders, however, may choose to calculate the interest on your mortgage daily and adjust payments when there’s any change to the savings balance.
Can you overpay an offset mortgage?
Essentially an offset mortgage is similar to overpaying. But unlike overpaying on a standard mortgage, an offset is flexible and grants you access to the money used for overpayments.
Most lenders allow you to offset up to 100% which means you won't have to pay any interest. However, you will still need to pay the monthly repayment under the terms of your loan agreement, but there won’t be any interest charged – the whole amount will go towards paying off the loan.
If your lender is one that insists on borrowers paying the same amount each month, then you will need to continue to do so. And if at any time your savings balance goes over 100%, you won't be paid any interest on the surplus, so you’re better off finding an interest-paying account in this scenario.
How do I know if an offset is right for me?
There’s no one-size-fits all when it comes to mortgages. Whether an offset mortgage is the best option for you depends entirely on your own personal circumstances and the figures you are dealing with.
If you've got cash in a low interest savings account, you could save more with an offset mortgage. But we’re not talking small sums when it comes to savings – you need to have a reasonable level of savings to make it worthwhile to pay the higher rates charged by an offset deal.
Also, if you expect you might need to dip into your savings in the near future then it’s possibly not worth an offset loan either.
If paying down your mortgage is your goal then an alternative is to look into overpaying your standard mortgage – just make sure you check overpaying is within the rules of your agreement.
The best way to work out if it is the right option for you is to speak to a mortgage broker. They are experts in the market and will be able to find you the most appropriate and best value mortgage deal available to you.
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