Offset mortgages – what are they and who should choose one?

Finding the right mortgage to meet your personal financial needs and goals can be tricky with so many different mortgage deals to choose from. Offset mortgages are unique in that they can reduce the amount of interest you pay on your mortgage and may even help you pay your mortgage off early. In this article, we explain how an offset mortgage works and when it may be a good idea to explore this type of mortgage.

What is an offset mortgage?

An offset mortgage is one where the interest charged on your mortgage balance can be offset against the value of savings that you hold in an account alongside it. With an offset mortgage, the interest that you pay on your mortgage balance is calculated by reducing the mortgage balance by the amount you hold in savings and applying the interest rate to the remainder of the mortgage balance - in other words, you only pay interest on the amount of your mortgage balance over and above the amount of your savings balance.

How does an offset mortgage work?

Offset mortgages are designed to reduce the amount of interest that you pay on your mortgage if you have savings. Essentially, the portion of your mortgage loan amount that is matched by your savings amount will not attract interest. As long as your mortgage interest rate is equal to or greater than the interest rate you could be paid on your savings, this can be advantageous, especially when you factor in the tax charge on interest earned on savings.

You can arrange an offset mortgage with savings that are equal to your mortgage loan amount meaning you don't pay any interest on your mortgage at all as it is all offset. Or, you can choose to partially offset the mortgage loan amount and this may be subject to the lender's mortgage criteria. It is worth bearing in mind that when you repay your mortgage on a capital and interest basis, as the mortgage balance reduces, your savings may offset a larger portion of your mortgage loan.

In other words, the effect is the same as if your were to overpay a loan but with the added benefit that you don’t actually give any money away, so you still have access to it.

As with other types of mortgages, an offset mortgage can be arranged with a fixed, variable or tracker interest rate. If your mortgage rate is not fixed then you should review the arrangement regularly to ensure that the savings you make in mortgage interest remain greater than those you could potentially earn from a savings account.

Offset mortgage example

If we assume the following is true of how you have arranged your savings to offset your mortgage:

• Mortgage loan amount - £300,000
• Savings offset against mortgage loan - £50,000
• Mortgage interest charged on £250,000

You could stand to save around £170 on your monthly payments if your mortgage interest rate is around 4.2%. This is assuming you're not earning interest on your savings elsewhere though, so you have to weigh up the savings against what you can expect as a return on savings but remember to factor in the tax that you may have to pay on the interest you earn on savings too. If you choose not to take the reduction in your monthly mortgage payment, the offset will mean that your mortgage is repaid sooner as a result of overpaying which may appeal to

Do banks still offer offset mortgages?

Yes, a number of banks and building societies still offer offset mortgages including Barclays, Yorkshire Building Society, and Virgin Money. Some lenders, including First Direct and Santander continue to offer an offset mortgage for existing mortgage customers with this arrangement but, at the time of writing, do not offer these for new customers.

Some lenders offer more flexibility in the offset mortgage arrangement than others, and the criteria for qualification may also differ, so it is best to speak to a mortgage broker* who can steer you to the best offset mortgage deal based on your circumstances and goals.

Best offset mortgage deals

Offset mortgage deals are usually a niche product and the deals may not be listed on mortgage comparison sites so there is a little more work to do when it comes to find the best offset mortgage deals in the market. Here are some of the best offset mortgage deals available to residential customers at the time of writing this article:

• Coventry Building Society - 2 Year Fixed Rate Offset Mortgage up to 75% loan-to-value with an interest rate of 4.34% and a product fee of £999
• Yorkshire Building Society - 2 Year Fixed Rate Offset Mortgage up to 75% loan-to-value with an interest rate of 4.52% and a product fee of £495
• Barclays - 2 Year Tracker Offset Mortgage up to 75% loan-to-value with an interest rate of 5.47% and a product fee of £1,749

Are offset mortgages a good idea?

If you are a mortgage borrower with savings, you may want to consider taking out an offset mortgage. Like any financial decision, you have to weigh up the advantages and disadvantages of choosing an offset mortgage compared with a standard mortgage. Mortgage deals are offered based on your financial circumstances and the rates will vary depending on the lender you choose and how much money you wish to borrow. It is worth remembering that better mortgage rates are usually available to those with a larger deposit, making the loan-to-value ratio more attractive to a lender, and this may also determine whether you are better off using your savings towards your deposit instead of sitting them in a savings account to offset your mortgage interest.

Pros and Cons of an offset mortgage

Pros

• Save on the interest on your mortgage balance (as long as the interest rate on the savings is lower than it)
• Maintain access to savings
• Pay off your mortgage earlier

Cons

• You may miss out on better returns if your savings were invested
• The rates available for an offset mortgage may not be as attractive
• Paying off part of your mortgage using your savings instead may offer you a better mortgage deal

How to decide if an offset mortgage is for you

It can be difficult to decide which type of mortgage is best for you, especially as this is a long-term financial commitment. You may wonder whether building a savings reserve to offset the interest on your mortgage is the best use of your capital - could you earn a greater return by investing this, perhaps? This needs to be considered carefully, and it is often best to engage the help of an independent mortgage adviser who can source the best mortgage deals based on your income, loan-to-value ratio and other financial goals.

Habito* is an online mortgage broker that gives mortgage customers access to a wide range of mortgage deals quickly and easily. The experts at Habito can help guide you through the various options until you find one that you are happy with. There is no charge for Habito's services as they are paid directly by the mortgage lender for placing your business.

You can also use VouchedFor* to find a reputable mortgage adviser in your area who will search the mortgage market before presenting you with mortgage deals based on your personal circumstances. As a Money to the Masses reader, Vouchedfor will review your mortgage free of charge and the mortgage brokers are all 5-star rated.