What are Offset mortgages and who are they best suited to?
How Offset works
An Offset mortgage is a product that allows a borrower to ‘link’ their savings to their mortgage account. Borrowers only pay interest on the difference between the Offset savings balance and the mortgage amount, so their savings reduce the mortgage interest they pay.
An Offset mortgage is straightforward and can be taken out on a residential property, subject to meeting lending criteria. For example, somebody who has an outstanding mortgage amount of £200,000 and has £50,000 in a linked savings account would only pay interest on the £150,000 difference. However, this borrower would not earn any interest on the savings their mortgage is linked to.
With a necessary savings element, Offset mortgages are clearly not suitable for everybody. But although the current cost-of-living crisis is an acute and growing problem for a significant number of people in the UK, there are still a number of households with sufficient savings that could take advantage of an Offset mortgage. With many borrowers set to experience an increase in their mortgage repayments, Offset mortgages could be a good way to mitigate some of the impact.
Many lenders offer a repayment or interest-only option for Offset mortgages. These work in the same way as traditional mortgages – a repayment product means borrowers pay both capital and interest payments each month. An interest-only mortgage sees them pay just the interest on the outstanding balance, with the original amount borrowed to be repaid at the end of the mortgage term.
The advantages of an Offset mortgage
For those who choose an Offset mortgage can enjoy many benefits, including:
• Putting money to work: Although any money put into a savings account linked to an Offset mortgage won’t earn interest, the money saved through paying interest only on the difference rather than the full mortgage amount – called the offset benefit – can provide more value in the long term than the interest earned from savings would.
• Easy access to money: Overpaying a mortgage is a popular way of reducing a mortgage term and/or monthly payment amounts. However, once that money is paid to the lender, the borrower can no longer access it. With some Offset mortgages, money saved could be withdrawn at any time and with no penalty – although, of course, the offset benefit will shrink.
• Benefit from greater tax efficiencies: Interest saved through funds stored in Offset savings doesn’t count towards the personal savings allowance.
• Reduce the mortgage term or help to lessen the impact of rising rates on monthly mortgage repayments: With a repayment Offset mortgage, borrowers can choose to decrease either their mortgage term or the amount they pay each month. With an interest-only mortgage, monthly payments or the outstanding balance can be reduced.
Opting for a repayment Offset mortgage also means the offset benefit reduces the outstanding balance, which lowers the amount of mortgage interest paid, therefore shortening the mortgage term. On the other hand, if a borrower wants to keep the same term length over the lifetime of the mortgage, they can reduce their payment amount by opting to automatically put their offset benefit towards their subsequent monthly payment, helping with monthly outgoings.
With an interest-only Offset mortgage, monthly mortgage payments can be lowered through the same method as with a repayment mortgage, or the offset benefit is credited to the outstanding mortgage balance owed, meaning a lower pay off amount at the end of the mortgage term. And while ISAs also offer tax-free savings, they are limited to deposits of £20,000 per tax year.
Dispelling some common misconceptions
An Offset mortgage is linked to a single Offset savings account, which works much like a regular savings account does – deposits and withdrawals are made as normal.
Some people also believe that an Offset mortgage requires a minimum savings deposit, but many lenders now have no such barrier to entry nor any limits on how many times savings can be withdrawn. Today, with a lot of Offset products, any amount of money can be credited to a current or savings account and used with any level of activity.
Another common myth is that these products are not flexible. Some lenders allow penalty-free withdrawals at any time, and money can be deposited into a savings or current account at any point. Small monthly amounts saved in this way can make huge long-term changes to the cost of the mortgage.
An Offset mortgage could provide an excellent opportunity for:
• People with high cash savings – and who are happy to keep it in an account to make the most of the Offset benefit.
• Higher and additional rate taxpayers – because interest saved through money stored in Offset savings is not taxed.
• Somebody who has received an inheritance – especially if they’re not sure what to do with it or are unfamiliar with handling significant lump sums of money.
• The self-employed – for two reasons. First, many self-employed people receive irregular income, so offsetting to minimise monthly repayment bills can be useful. The second reason is that some self-employed people keep a large sum of cash handy for tax bills during the tax year – this can be put to work instead of it sitting in a cash account attracting low rates.
• People with high cash savings – and who are happy to keep it in an account to make the most of the Offset benefit.
• Higher and additional rate taxpayers – because interest saved through money stored in Offset savings is not taxed.
• Somebody who has received an inheritance – especially if they’re not sure what to do with it or are unfamiliar with handling significant lump sums of money.
• The self-employed – for two reasons. First, many self-employed people receive irregular income, so offsetting to minimise monthly repayment bills can be useful. The second reason is that some self-employed people keep a large sum of cash handy for tax bills during the tax year – this can be put to work instead of it sitting in a cash account attracting low rates.
• Buy to Let landlords – to help with the mortgage repayments for their own residential mortgage and to potentially ease the impact of the recent tax changes, whereby landlords can no longer deduct interest payments when declaring their annual rental income.
In short, an Offset mortgage, in allowing savings or current accounts to be linked to an outstanding mortgage balance, is a flexible way of reducing the amount paid on mortgage interest, reducing the length of a mortgage term, or lowering monthly repayments.
Such a product suits people with different levels of savings, including borrowers who often operate with cash savings for specific periods of time, such as the self-employed, and higher- and additional-rate taxpayers, because any interest saved does not attract tax. However, depending on individual financial habits, the net can be cast much wider than this.