When most people think about mortgages, what probably comes to mind is a typical repayment plan, where you put down a deposit and make repayments every month which covers your loan on top of the interest owed. However, there are many more unconventional ways of getting your foot onto the ladder, one of which is an interest-only offset mortgage.
Customers approach us all the time asking about this type of mortgage, and while interest only offset mortgages are less common in the UK these days, they do still exist, and there are a handful of lenders out there that offer them.
This article is going to discuss this product in more depth, and will be covering:
An offset mortgage is a mortgage which is linked to one (or more) bank or savings accounts. The balance on these savings are then used to reduce the interest charged against the mortgage, therefore saving you money.
On a standard repayment plan, interest payments are calculated on the total amount you owe. The savings balance is not actually used to repay a mortgage but ‘sits alongside’, essentially as a provisional overpayment, which allows buyers to dip into the account if needed.
As with all interest-only mortgages, you are responsible for paying off the capital at the end of the mortgage term. This means that you will need to have a solid plan in place in order to be able to repay the outstanding capital once the term is over - this is called setting up a “repayment vehicle”, which we’ll cover later on.
How does an offset mortgage work in practice?
To explain the concept more clearly, it’s easiest to use an example:
Supposing you take out a mortgage for a property valued at £200,000 at an interest rate of 3%, and you have £30,000 set aside in a savings account. By offsetting these savings against the full mortgage amount, you will only have to pay interest on a total of £170,000.
The interest rate on the total mortgage amount would come to £6,000 per year. However, if you calculate the interest on the offset amount only it comes to £5,100, therefore saving you £900 annually.
If the savings had been left in an account paying 2% interest, for example, you would have earned £600; £300 less than what you have “earned” from the mortgage. Bear in mind though, that if you withdraw any money from the linked savings / bank account, the repayment amount will increase proportionately.
Why choose an interest only offset mortgage?
Historically, offset mortgages have had higher rates than alternative plans, and typically you would have needed a lot of savings (typically around 25% of the property’s value) to make offsetting worthwhile. However, this gap has since narrowed and nowadays more competitive rates available, meaning offsetting could be a good solution for more people.
In addition to the annual savings you could potentially benefit from, an offset mortgage offers you the choice of paying back the loan over a shorter term, or making lower monthly payments. This is because mortgage payments are based on the full loan amount rather than the offset figure.
Borrowers are therefore technically “overpaying” each month, thus reducing the length of time it takes to pay back the total. Depending on how much you have in offset savings, your mortgage term could potentially be decreased by months or even years.
On the other hand, if you have these sort of funds available in savings when you’re looking to buy a property, you may be better off putting it towards your deposit rather than into an offset account.
It is all very much dependent on your individual circumstances, how competitive the rates are, and if you are prepared to tie up all your savings into a property, where you are unable to access them.
If you’re sceptical about ‘putting all your savings into one basket’, an offset mortgages gives you flexibility in the sense that they allow you to withdraw cash from your savings account whenever you need to, for whatever reason.
So what are the key benefits?
The main benefits of an interest-only offset mortgage are as follows…
Allows for the possibility of paying off a loan at a quicker rate than with a standard mortgage.
Opportunity to reduce monthly repayments.
Access to your savings if you need to make withdrawals.
Some lenders allow you to offset both savings, ISAs and current accounts against your mortgage.
The interest saved will usually exceed the amount that can be earned from a savings account.
Enables borrowers to breach the threshold in savings interest without having to pay tax.
Are there any disadvantages?
Like any mortgage product, interest only offset mortgages have some drawbacks you should be aware, such as the ones listed below.
For this reason, it’s important to speak with a whole-of-market advisor to discuss whether this is the right option for you before pressing ahead. Make an enquiry and one of the experts we work with will discuss all of your options and make sure you’re paired with the right lender.
Interest rates on offset mortgages can be higher than standard repayment mortgages.
Not many lenders offer offset mortgages, so choice can be limited and rates less competitive.
Could be more financially beneficial to use savings for a bigger deposit.
May not earn interest on savings accounts linked to the mortgage.
Payments may increase if a withdrawal from offset savings is made.
LTV is often lower for offset than conventional mortgages.
In many cases the linked savings account and mortgage will need to be with the same provider.
Am I eligible for an offset interest only mortgage?
We discussed earlier that, as with any interest-only mortgage scheme, having a repayment vehicle in place which guarantees you are able to cover the remaining capital at the end of the period is a must.
What’s more, lenders will require proof that your proposed repayment plan is legitimate. Acceptable repayment plans vary from lender to lender, but generally most are happy with the following:
Sale of a second property
Stocks and shares
Stocks and Shares ISAs
Your mortgage provider will also require evidence of your repayment plan, either in the form of recent bank / savings statements, latest projection statements, valuations of stocks and shares, and for the sale of another property, a certificate of ownership and evidence of any outstanding mortgage debt.
If you plan to use investments to repay your mortgage, you should provide recent statements, and it is advised that you check in with your financial advisor on a regular basis to ensure your investments are on track.
How much deposit do I need for an interest only offset mortgage?
In addition to a sound repayment plan, most lenders will have lower loan to value (LTV) requirements than you’d expect with a typical repayment mortgage, meaning you will be required to have a higher deposit together for the property. This is to do with the associated risk with all interest only mortgages.
Your LTV has a big impact on the rates you’re offered, and most providers will want a minimum of 75% LTV (25% deposit saved), although you may get a handful that will consider an LTV of 80/85% - but expect interest rates to be far less competitive.
How can I get the best interest only offset mortgage rates?
To be considered for the best mortgage rates, you’ll need to try to save up a minimum of 25% deposit, or more if you can afford to do so. This shows the lender that you are a financial responsible and hence, a lower risk.
What are the income requirements I’d need to meet?
There are also a few other concepts to consider which may impact eligibility. Firstly, the handful of lenders that do offer this type of mortgage will usually have minimum income requirements so as to prove your affordability, as well as a minimum sum they allow you to borrow for the term.
Some lenders have a minimum income requirement of between £15,000 and £20,000 per year for any residential interest only purchase; others it’s between £30,000 and £40,000, and a minority require even more than that.
In addition, while providers are generally happy for you to make unlimited over-payments to reduce the length of your term for your offset mortgage, early repayment charges often apply.
What property type can interest-only offset mortgages be used for?
As covered, there are very few lenders out there who offer offset mortgages, and those that do have very strict eligibility criteria. The most commonly accepted applications are those who are looking to purchase their main place of residence, as it makes sense for buyers to use personal savings to fund buying their own home.
If you’re looking to take out a offset mortgage for commercial purposes and / or an overseas property, we advise you get in touch with an advisor who can discuss your situation with you in more detail and let you know your options.
How would bad credit affect my eligibility?
As with any type of mortgage, a history of bad credit does not look good to lenders, and this is probably the most significant factor affecting eligibility for an interest only offset mortgage. This is because, as with any type of interest only plan, lenders need to be extra confident that you will be able to repay what you owe, because when the term comes to an end you still need to pay back the full capital of the property.
A history of defaulting on payments, or other instances of bad credit, will almost certainly trigger warning signs for lenders, and could seriously impact whether a provider is willing to lend to you. For those that are, you will probably find you’ll be offered far less competitive rates than someone with clean credit, may request a larger down payment.
However, a history of bad credit is not necessarily the be all and end all. The type and severity of the issue(s), as well as how long ago they occurred, will all influence your application considerably. A couple of minor instances from years ago, for example, may not affect your situation at all. In a nutshell, the more recent and more severe the instance, the less favourably you will be looked at by lenders.
Here are some of the most common bad credit instances, from minor to severe; the more severe the case, the more it will affect your eligibility:
Low credit score
County Court Judgements (CCJs)
Individual Voluntary Arrangements (IVAs)
Debt Management Plans (DMPs)
Can I get an interest-only offset mortgage on a Buy to Let property?
As mentioned above, it is more common for borrowers to get an interest-only offset mortgage on their primary home. However, a handful of lenders will also lend for buy to let (BTL) investors. Since the tax changes in 2017, this may be an attractive prospect, as it allows investors to use personal savings to reduce their tax bill. Offsetting savings against your BTL mortgage reduces the amount of interest charged, which increases the profit obtained from letting, and simultaneously, your cash flow.
Can I get a large loan on an interest-only offset basis?
If you’re looking to take out a particularly large loan it is possible to obtain on an interest-only offset basis - provided you meet the affordability requirements. If you can provide evidence that you are able to keep up with the monthly repayments on a larger loan, some lenders will be happy to consider you. The amount of savings you have and the reliability of your repayment vehicle will be a vital consideration.
When it comes to interest-only offset mortgage, does age impact eligibility?
Typically, older borrowers experience more difficulty when being approved for a home loan due to the perceived risk. As interest-only offset mortgages are typically harder to come by, older people may struggle to be approved for this type of loan - but that doesn’t mean it’s impossible.
Contact us today and we’ll put you in touch with one of the experts we work with specialising in this area.
Second homes and interest-only offset mortgages
Lenders tend to be more skeptical when it comes to lending for second properties because of the perceived risk involved. Mortgage providers want to be certain that you will be able to keep up your repayments, and if you are already committed to paying a mortgage on your primary home.
Again, eligibility will be determined based on whether you can reasonably afford a mortgage for two properties, how reliable your repayment vehicle is, as well as other factors already covered.
Interest-only offset mortgages and non-standard properties
Every lender has their own approach to non-standard constructions, but typically higher loan to values and earnings ratios are required, as these properties are perceived as a less stable investment and more difficult to sell on.
If you’re looking to take out an interest-only offset mortgage, you may be even more limited when it comes to lenders - but don’t give up hope. Speak to one of our experts specialising in this area and they can put you in touch with willing lenders.
Speak to an interest-only offset mortgage expert today
When it comes to interest only offset mortgages, we can’t stress the importance of getting in touch with a specialist advisor to discuss your situation in more detail. An advisor will consider your individual circumstances alongside many other factors, and help decide whether it’s the most best move for you.
For more information, call Online Mortgage Advisor on 0800 304 7880 or make an enquiry here. Then sit back and let us do all the hard work in finding the broker with the right expertise for your circumstances. We don’t charge a fee, and there’s no obligation or marks on your credit rating.
*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The info on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs. Some types of buy to let mortgages are not regulated by the FCA.Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.
Pete, an expert in all things mortgages, cut his teeth right in the middle of the credit crunch. With plenty of people needing help and few mortgage providers lending, Pete found great success in going the extra mile to find mortgages for people whom many others considered lost causes.
The experience he gained, coupled with his love of helping people reach their goals, led him to establish Online Mortgage Advisor, with one clear vision – to help as many customers as possible get the right advice, regardless of need or background.
Pete's presence in the industry as the 'go-to' for specialist finance continues to grow, and he is regularly cited in and writes for both local and national press, as well as trade publications, with a regular column in Mortgage Introducer and being the exclusive mortgage expert for LOVEMoney. Pete also writes for OMA of course!
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