Interest-Only Offset Mortgages Explained

Mortgages can work in many different ways. The most basic involves saving a deposit of around 10% of the property value, borrowing the rest, and paying it back over 25 years. But, for people with unconventional financial situations, there are more complex options.

One of these is an interest-only offset mortgage. This product is used in specific circumstances where a buyer has significant cash savings (not wanting to put towards the property purchase) and a future income event or events that will pay off their mortgage. This might sound confusing, but we’ll explain everything in this guide.

What is an interest-only offset mortgage, and how does it work?

This type of mortgage combines two key features:

• “Interest-only” means that your monthly repayments do not pay off the loan amount, only the interest due. The loan balance is usually repaid at the end of the mortgage term.
• “Offset” means that the mortgage is linked to a cash savings account, with the money in that account earning no interest and theoretically deducted from the amount you owe. This reduces the interest due each month on the mortgage loan.

Here’s an example: Let’s say you have a mortgage for £200,000, and you have £50,000 in a savings account. If you use these savings to offset the mortgage, you only need to pay interest on £150,000 instead of the total amount. You’ll pay this interest monthly and, at the end of the mortgage term, repay the £200,000 loan amount.

Advantages and disadvantages

Here are some of the main advantages of interest-only offset mortgages:

• By offsetting your savings against your mortgage, you can reduce your monthly repayments
• As long as the interest rate on your mortgage is higher than the interest rates available on cash savings, you will save money overall.
• Your savings still belong to you, so you can dip into them if you need to
• You will pay less each month because you are not making capital repayments
• An offset mortgage can reduce your tax bill as you won’t receive interest on the portion of your savings you offset

However, no mortgage is entirely without drawbacks.

In this case, they are that:

• The interest rates for this type of mortgage are higher than for other mortgage types
• You won’t earn any interest on your savings so inflation will decrease their value over the long-term
• If you need to dip into your savings, this will cause your mortgage repayments to rise
• At the end of the mortgage, you will need a strategy to repay the whole of the initial loan amount
• There is a limited choice of lenders offering this type of mortgage

With these drawbacks in mind, you should consider whether you would be better off using your savings to put down a larger deposit. This could give you access to better interest rates and potentially reduce your monthly repayments even further. In this case, the downside is that your wealth would be locked up in property, not accessible in cash.

Why you should speak to a broker before you apply for an offset mortgage

Before proceeding with an interest-only offset mortgage application, speaking to a broker who specialises in this niche product type is sensible.

They can help you in numerous ways…

• They can provide all the information you need about interest-only offset mortgages and the various alternatives and can answer any questions you have
• They will give you their expert opinion on the best mortgage type based on their understanding of your financial situation.
• Whichever mortgage you apply for, they will compare deals from all the different lenders and use their market knowledge to find the best rate available for your circumstances.
• They will help you with your application to make the whole process quicker and easier.

Lenders and their eligibility criteria

Only around ten lenders offer offset mortgages, including Accord Mortgages, Barclays, and Scottish Widows. In specific scenarios, they will consider providing an offset mortgage on an interest-only basis.

The eligibility requirements (e.g., age, credit history) are mostly the same as for other mortgages. You can learn about these general mortgage criteria here.

However, with interest-only offset mortgages, there are some notable differences:

Property type

Interest-only mortgages aren’t usually used to buy your main home. They’re a far more common choice for a second home or buy-to-let transactions. Often, your repayment strategy will involve selling another property you own.

There are, however, a smaller number of lenders who offer them on a residential basis.

Repayment strategy

Your lender will want to know how you intend to repay the loan amount at the end of the mortgage period.

The permitted methods vary between lenders, but include:

• Selling another property (mortgaged or unmortgaged)
• An existing endowment policy or ISA
• Annual lump sums (e.g. bonuses)
• Other investments
• A pension lump sum

Income

Each lender who offers this type of mortgage has a different minimum income requirement, which may depend on the circumstances. For example, Scottish Widows requires a minimum income of £100,000 if your repayment strategy is selling a mortgaged property. Others have no minimum income requirement.

Deposit

These mortgages are considered riskier than others and require a larger deposit of about 25% of the property’s value.

Get matched with an interest-only offset mortgage expert

As this is a niche area of the mortgage market, not every broker has the expertise to advise you. You must speak to someone who understands both offset and interest-only mortgages. If you’re looking into these mortgages because of your unusual income pattern, you’ll need someone who can understand its nuances.

We work with hundreds of brokers and offer a matching service to help people find the specialist best suited to their precise needs. You can use this service for free to set up an initial, no-obligation chat with a broker who specialises in interest-only offset mortgages.

To try it, call us on 0330 818 7026 or enquire online.