What is an offset mortgage?

For some homeowners, offset mortgages could be a great way to save money on their borrowing. These deals could either reduce their monthly repayments, or shorten the mortgage term and help them get mortgage-free sooner. Yet many don’t realise their potential, and as a result could be missing out on some welcome savings. Let’s take a closer look at offset mortgages and how they could help you.

How does an offset mortgage work?

Offset mortgages let you link your mortgage to your savings, with the savings balance being used to reduce the amount of interest charged on the mortgage.

The way this works is by having your savings ‘offset’ against the value of your mortgage, so you'll only pay interest on your mortgage balance minus your savings balance. Your savings don't actually repay any of your mortgage, they just sit alongside it and save you interest. Some providers will let you offset the balance of your current account too.

You could use this saving to lower your monthly payments, or you could shorten the length of your mortgage term by keeping your repayments the same. The former allows you to save money each month, while the latter keeps your payments the same but gives you the chance to pay off your mortgage earlier.

A key part of this arrangement is that your savings can still be accessible – there’s no need to lock them away in a fixed account. Just bear in mind that if you withdraw your cash you’ll have less to offset against your mortgage, which could increase your monthly repayments. It’s also important to note that your savings won’t earn any interest, but the amount you’ll save on mortgage interest could more than make up for it.

How much could an offset mortgage save?

Let’s say you have a mortgage of £150,000 and you’re paying an interest rate of 4.00% on a mortgage with a 25-year term. You also have £20,000 in a savings account.

If you didn’t have an offset mortgage, your monthly repayments would be £791.76. However, by offsetting your £20,000 in savings, you’d only pay interest on £130,000 of your mortgage, which would result in monthly repayments of £686.19 – and over the course of the year, this could give you savings of £1,266.84.

Conversely, if you'd have left that £20,000 in a savings account paying the same rate of 4%, you would have earned just £800 in interest over the year. If you have to pay tax on your interest it would be even less, and you’d still have to pay the almost £1,300 you didn't save on the mortgage.

Bigger deposit vs. offset mortgages

If you’ve got the cash readily available, you may be wondering if you should put down a bigger deposit instead of offsetting. The benefit of increasing your deposit is that you’ll be able to lower your loan-to-value (LTV), which in turn will result in lower mortgage rates (and therefore repayments) from the outset.

However, if you kept some of the savings back to offset, you could still pay interest on the lower amount, and would also keep your savings accessible in case you needed them later on. The drawback here could be that mortgage rates tend to be a little higher for offset deals, so it’s important to factor this into your calculations to thoroughly weigh up the options.

Can you access your savings with an offset mortgage?

Yes. Because your savings are kept in a separate savings account rather than being used directly towards your mortgage, you can still access them should you need to. However, bear in mind that usual access rules will still apply depending on the savings account you choose, so if your savings are in a fixed bond, you’ll need to comply with the terms.

But ultimately, it doesn’t have to be locked away, and you should be able to get at your money quickly if you needed to – or at least more easily than if it was tied up in your home.

It’s also worth noting that once your savings are offset against your mortgage, you can still add to them, which could bring down your mortgage payments even further. Just bear in mind that the opposite also applies, and if you needed to withdraw your savings, your mortgage repayments would likely increase.

Offset mortgages for first-time buyers

There’s a specific kind of offset mortgage that’s designed to help first-time buyers afford their new home. Known as a family offset mortgage, this sees the mortgage amount linked to a parent or grandparent’s savings account and the balance offset against it, reducing the amount of interest paid by the homeowner themselves.

Just bear in mind that this is different to a guarantor mortgage – a deposit will still need to be paid, unlike with 100% mortgage deals where a guarantor would be required to put up their home or significant savings pot as security. Yet this could still offer a great option for anyone wanting to support their child (or grandchild) get onto the property ladder without needing to physically gift them the money for a property.

Are offset mortgages worth it?

The answer to this can be different for each borrower, but for many, offset mortgages could certainly be worth considering. This could particularly be the case for higher rate taxpayers who find they need to pay tax on their savings interest – by offsetting their savings instead, they’re not only saving tax but also reducing the amount of interest they have to pay on their mortgage.

It can depend on the interest rates you’re receiving as well. Those who are able to secure a higher savings rate may find it makes more sense to earn that amount of interest, while those with a higher mortgage rate could think the opposite. Yet the lack of savings interest could be a deal-breaker for some, particularly if they rely on that interest as a form of income.

However, some could be simply be wary of offset mortgages because of common misconceptions, such as their savings will be locked away or they need a significant amount to make it worthwhile. In reality, your savings are likely to remain accessible, and even a small sum can make a big difference – indeed, even a modest pot of £2,500 could shorten a £100,000 mortgage by seven months over a 25-year term!

What to consider before applying for an offset mortgage

Here are a few key things you need to consider before applying for this kind of deal:

• Are you paying more interest on your mortgage balance than you’re earning from your savings?
• Would you be happy with a slightly higher mortgage interest rate if it meant you could reduce your repayments and potentially your mortgage term by offsetting?
• Do you rely on your savings interest for income?
• Would you prefer to keep your savings accessible or use them towards a bigger deposit?
• Are you paying tax on your savings interest?

There’s a lot to think about when it comes to this type of mortgage, and it isn’t always easy to know which option would be best for you. You need to make sure you’re thoroughly running the numbers as well as getting access to the very best deals, which is why it’s recommended to speak to a broker.

They’ll be able to help you work out whether an offset mortgage would suit your circumstances, or whether you’d be better using your savings towards a deposit instead.