Whether it’s your first step on the housing ladder or you’re a few rungs up, the number of choices you have for your mortgage can be a bit overwhelming. Repayment, interest-only, tracker… which one do you choose?
One option not everyone knows about is an offset mortgage. This is a way to use your savings to reduce the amount of interest you pay on your mortgage.
How do offset mortgages work?
An offset mortgage is a type of flexible mortgage deal. It lets you over or underpay on your monthly repayments. It also reduces the amount of interest you pay on your mortgage debt.
With an offset mortgage, you have a savings account with the same lender as your mortgage. However much you have in that savings account, you don’t pay interest on that amount of your mortgage balance.
Let’s say you have £125,000 left to pay on your mortgage and £25,000 in savings. With an offset mortgage, you only pay interest on £100,000 of that (£125,000 of mortgage debt, minus the £25,000 in your offset account).
You’re effectively paying 20% less interest on your mortgage. Only caveat is, you don’t earn any interest on the amount in your savings account.
An offset mortgage can lower your mortgage costs over the years in two ways:
- You save on your monthly mortgage payments, as you’re paying less interest. You save money overall if the interest you save on your mortgage is worth more than the interest your cash would earn in a regular savings account.
- If you choose to continue to make the monthly payments you would have made without offsetting, you’ll be making an overpayment each month. You'll reach the goal of owning your own home outright earlier and save money by reducing the length of your total mortgage term.
Reasons to choose an offset mortgage
The main advantages of an offset mortgage are:
You enjoy easy access to your savings
You’ll still have to keep a minimum amount of money in your offset savings account, and withdrawing from it will make your mortgage interest rate higher. But you’ll still be able to access your cash easily.
You save the tax you would’ve had to pay on your savings
The cash in your offset savings account is working to pay off your mortgage. That means you don’t have to pay tax on it.
You can link your mortgage to someone else’s savings account
You need a linked savings account for an offset mortgage, but it doesn't always have to be your own. Not all lenders offer a family offset mortgage option, but it’s a good option for family members or parents who want to help their adult children buy a property. It lets them contribute to monthly mortgage payments over the whole term of the mortgage rather than giving a lump sum.
Reasons not to offset
Although an offset mortgage gives you flexibility and can save you money, it isn’t the right option for everybody. Here are some of the drawbacks:
The interest you do pay will be at a higher rate
Although you won’t be paying interest on your entire home loan, the interest rate you do have will probably be higher than it would be on a regular repayment mortgage. This tends to be the case because lenders need to balance the likelihood that offset mortgage customers will withdraw money from their linked account, so they charge higher interest rates.
You’ll need a lower LTV than other mortgages
LTV is loan to value, a measure of the size of your mortgage compared to the value of the property. Typically, the lowest LTV lenders will consider for an offset mortgage is 75% (so you’ll pay at least a 25% or £62,500 deposit on a £250,000 property, for example).
You’ll need to be able to afford a bigger deposit while still leaving enough money in your savings to make offsetting worthwhile.
Your savings won’t earn any interest
Although you don’t pay tax on the savings from an offset mortgage, you don’t earn any interest on them either. Even though the interest rate on savings accounts is generally rock bottom, some people can use their interest as a source of income which they would then miss out on if they offset their mortgage.
You’ll have fewer options for the rest of your cash
Your linked bank account and mortgage loan have to be from the same lender, but not all lenders provide offset mortgages. So if you’re set on an offset mortgage, you’ll have a smaller selection of lenders to choose from than you would for a standard mortgage. A mortgage broker (like Habito) can help you compare your options.
So should I get an offset mortgage?
If you’re a first time buyer, an offset mortgage isn’t usually the best option, because you'll need a lot of savings as well as a deposit. For most first time buyers, it makes more sense to use your savings to put down a larger deposit, which can help you get a lower interest rate on your mortgage.
If you have extra savings to spare, you could consider an offset mortgage, especially given the low rates for savings accounts we’ve seen recently. It’s a way to make your money work for you while savings interest rates are low.
More reasons you might want to explore the idea of an offset mortgage:
You want to renovate the house you’ve bought
Because offsetting lets you keep dipping into your savings, you’ll be able to pay for any building work you’re planning to turn your property into your dream home.
You’re a higher rate taxpayer or additional rate taxpayer
If you’re paying a higher tax rate, an offset mortgage will keep more money in your pocket. You won’t pay tax on your savings, and they won’t eat into your Personal Savings Allowance. This can save a significant amount.
Your job gives you large bonuses
If you have a job where you get bonuses that you don’t need to cover your daily expenses, offsetting lets you put the extra money aside and make it work for you.
If you’re self-employed, you’ll have to set aside a portion of your profits for your annual tax bill. Because you still need to access this money, but can’t touch it before your tax bill is due, you could put it in an offset account. Especially if your lender lets you underpay in the months after the taxes are due.
You’re a landlord
Although offsetting isn’t usually an option for buy-to-let mortgages, if you’re a landlord, you can still use the cash you receive from rent to offset your own residential mortgage.
How to apply for an offset mortgage
If you think an offset mortgage is a good option for you, you’ll need to gather the information you need to apply for any other mortgage or remortgage, and show you meet the lender's eligibility criteria. You’ll need paperwork to prove:
- Your identity
- Your current address
- Your income, benefits and pension
- Your savings
- Your outgoings, like student loans, existing mortgage payments, or child maintenance
- Any repayments you’ve missed in the past that could negatively impact your credit rating
You can use calculators on different websites to get an idea of the banks or building societies with the best offset mortgage rates for your circumstances. A mortgage broker can help you make sense of what’s out there and eventually apply. Of course, if it’s your first time dealing with the lender, you’ll need to open an account and transfer your offset savings balance before they can approve your mortgage.