An offset mortgage lets you use your savings to reduce your mortgage interest. Offsetting is when the lender calculates your mortgage interest based on the total loan, minus whatever savings you hold with them – reducing the amount you’ll owe.
Unlike using your savings to make mortgage overpayments, with an offset mortgage, your savings remain accessible to you if you need them, but you can still use them to help you repay your mortgage more quickly.
They are available on both purchase and remortgage products and as interest-only or repayment, however, they typically work best with a repayment mortgage.
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Monthly payments are made in the same way as they are with any other repayment mortgage. You pay off a chunk of the capital and some of the interest with each repayment, and at the end of the mortgage term, you own your home outright.
With an offset mortgage, however, you have a savings account with your mortgage lender that is connected to your mortgage account. Some lenders will even allow you to link multiple savings accounts and/or your current account to the same mortgage.
Any savings held in linked accounts will be used to reduce the interest owed by offsetting the total savings balance against your outstanding mortgage balance.
For example: If you owe £100,000 on your mortgage, but have £20,000 in your offset savings accounts, you will only pay interest on £80,000 of your balance.
You won’t earn any interest on the savings in offset accounts, so to ensure offsetting is making the best use of your money, your mortgage interest rate would need to be higher than the rate you could earn savings interest elsewhere (after tax).
It can be, but it will depend on your circumstances. You don’t need a huge amount of money to use an offset mortgage, but those with a larger balance will benefit most.
If you have a large amount of savings, an offset mortgage offers the potential to save a considerable amount of money on interest over the duration of your mortgage. Keep in mind that you will need to leave the savings in the account to continue benefiting at the same level, however.
The savings you make on interest can either be used to lower your monthly repayments throughout the mortgage term, or you can continue to make the original monthly repayments, and reduce the length of your mortgage term.
The interest rates on this type of mortgage are not always the most competitive, however, so it’s worth weighing up how much you would be saving per month by offsetting your savings versus simply choosing a mortgage product with a lower interest rate.
With the vast majority of offset mortgages you can add to or withdraw from your linked savings accounts at any time. Some lenders may have a maximum number of withdrawals allowed in a particular period, however, or you may have to wait slightly longer to access your savings than you would when withdrawing them from a current account.
Don’t forget that your interest payments will increase if you take some of your savings out, as the balance in your offset mortgage account reduces. However, equally, if you add to your savings, you will increase the savings you’re making on interest even further.
Often the difference in the interest charged on mortgages is considerably higher than the rate of interest it’s possible to earn from a savings account. In many cases you will, therefore, be financially better off if you cut down what you’re spending out on your mortgage repayments, rather than trying to maximise your savings income.
Exactly how much you’re able to spend will depend on the following factors:
The interest rate on the mortgage
How much savings you have
The value of the property
You have a £150,000 mortgage at 4% APR over 25 years
£20,000 of savings deposited with your lender
You pay interest on £130,000 (even though you still owe £150,000)
You save around £800 in interest charges per year
Assuming your savings account is 2% AER, you’d be £400 better off each year by offsetting your mortgage.
This will depend on the terms and conditions of your mortgage and what kind of deal you go for. Most lenders let you overpay about 10% of the remaining mortgage balance each year, without charging an early repayment fee.
However, if you have an offset mortgage, instead of overpaying you can add to the money in your savings account, reducing your monthly interest charges. At the end of the mortgage deal, you can then use those savings to pay off a chunk of the capital you owe without paying any early repayment fees. This way you reap dual benefits from the same savings balance.
It’s unusual to find an interest-only offset mortgage, but there are a handful available. Typically this would be reserved for those buying buy-to-let properties to rent out for profit, rather than someone looking to buy their own residential home, however.
When savings rates are low, you can make your money work harder by reducing your mortgage interest payments
If you have lots of savings you may have to pay tax on the interest you earn, whereas mortgage offsetting is tax-free
You can reduce your monthly payments, but still access your savings in emergencies
Your money may get better returns in long-term investments or a high-interest savings account
Offset mortgages often have higher interest rates than other products
Your savings may be put to better use by increasing your deposit and getting a better LTV (loan to value) and therefore more competitive mortgage deal
An offset mortgage can be a good idea if you’re looking to lower your monthly repayments and have the savings to do it. There are a few different types of offset mortgage, so be sure you pick the best option for your circumstances.”
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