Pay less interest on your mortgage
Offset mortgages can save homeowners a significant amount of money on interest payments during the term of their home loan. With an offset mortgage, your mortgage savings and current account are grouped together under one provider. You won't earn interest on your savings or current account, but instead, your savings are offset against the outstanding mortgage and as a result, your total debt shrinks.
The example below shows how this works:
If you have a mortgage of £200,000 with an interest rate of 4% over a term of 25 years, your monthly repayments will be £1,066.87.
But if you have £50,000 in savings and you choose an offset mortgage at 4%, your total mortgage debt comes down to £150,000 so you only pay interest on this amount.
By only paying 4% on the £150,000, your mortgage payments come down to £899.87 a month.
TOTAL SAVING: £167 a month = £49,939 over 25 years.
Even if you don't have savings as high as £50,000 to put against your mortgage, you can still take advantage of an offset mortgage. Using the same example above, if you had £30,000 in savings, this would lower your monthly payments by £100 and save you £29,963 over the term of the mortgage. If you had £10,000 in savings, you would save £33 a month and £9,988 over the length of the mortgage.
You savings will still be accessible, but if you do withdraw money, the amount of mortgage debt on which you pay interest will go up, as the example below shows:
Using the previous example, your total mortgage is £200,000, but you are only paying 4% on £150,000 as you have £50,000 in savings. So your monthly repayments are £899.87.
However, you then need to withdraw £20,000 of your £50,000 savings. This means you now have £30,000 in savings so you're now paying the 4% on £170,000. This moves your monthly repayments up by £67 a month to £966.87.
Because you're saving interest, your savings can effectively earn more interest than you'd get in a traditional savings account, particularly at a time when interest rates are low and savers are earning next to nothing on their funds. What's more, offset mortgages can lower your tax bill. Income tax is normally payable on standard savings accounts, but with an offset mortgage, because you are saving interest and not earning it, you don't have to hand over any money to the taxman. Therefore offset mortgages are particularly beneficial for higher rate taxpayers.
But even if you're a basic rate taxpayer, providing your mortgage rate is higher than your savings rate after tax, you will be better off choosing an offset mortgage.
You have a mortgage for £150,000 and £10,000 in savings.
If you use your savings to offset your mortgage on a deal charging 4%, you could save £396 each year.
But if you put the £10,000 in a savings account paying 1.5%, you'd only earn around £120 each year in interest as a basic rate taxpayer. That's £276 less.
Even if you only had £5,000 in savings, if you offset it against your mortgage charging 4% you would save £192 each year.
If you put the £5,000 into an account paying 1.5% instead, you'd earn about £60 a year as a basic rate taxpayer, so £132 less.
The advantages of offset mortgages don't end there either. They are very flexible, allowing lump sum overpayments to be made or additional borrowing against overpayments. This can make this type of product ideal for the self-employed or those with unpredictable levels of income.
EXAMPLE – Overpaying your mortgage
You have a £150,000 mortgage with an interest rate of 4%. You have 25 years left on your mortgage.
You overpay by £500 a month.
You would pay off your mortgage 12 years and 10 months early...
And save £47,830 in interest.
Some providers also factor in credit cards and loans under the same interest rate and while the standard variable rate might be slightly higher than other mortgage providers' rates, the rate will be much lower than that of most loans.
You can get fixed-rate offset mortgages, but the most competitive priced deals are variable rate tracker mortgages. As always, you should compare deals carefully and don't forget to factor in the cost of any arrangement fees that come with the deal. If you are unsure where to start, talk to one of our fee-free mortgage brokers.
- Offset mortgages allow you to offset your savings against your mortgage
- You pay less interest on your debt
- Overpay on your mortgage if you can and your provider allows it
Offset mortgages are particularly beneficial for higher rate tax payers