Are Offset Mortgages A Good Idea?

In this article, we’ll look at the advantages and disadvantages of offset mortgages and explain why speaking to a whole of market broker is your best route to finding the right deal according to your situation.

What is an offset mortgage?

An offset mortgage allows you to use your savings to reduce the total amount of interest charged over the loan term. This is because the interest payable on your loan is reduced by (or offset against) the amount held in your associated savings account. The savings you make can be used to either reduce your monthly payments or the length of the repayment term.

It can sometimes be easier to explain with an example:

• Mortgage – £100,000
• Savings account – £10,000
• Result – You only pay interest on £90,000
• Benefit – You won’t pay any interest on £10,000 of your loan

You won’t earn any interest on the savings held in your offset savings account, but as interest rates on savings are typically lower than mortgage rates, it’s unlikely you’d have gained more in the growth of your savings versus interest paid. That said, this may not always be the case, so it’s important to check both rates and seek advice from a qualified broker.

Who qualifies?

Anyone with savings potentially qualifies for an offset mortgage, however, they are generally most beneficial to those with a large amount of cash liquidity, self-employed workers with fluctuating income or receiving regular commission/bonus payments, or higher-rate taxpayers.

Contractors often find this sort of mortgage especially beneficial, as it can help them avoid the 20% or 40% income tax payable on their savings. Instead, their offset returns are classed as ‘avoiding interest on the debt’, and therefore they will no longer be liable to pay tax on any savings linked to the mortgage.

What are the advantages?

The main advantage of an offset mortgage is that it enables you to reduce the amount of interest you pay over the term of your loan. They are generally more suited to borrowers with a significant amount of savings they do not need to dip into often.

With that said, even a relatively small amount of savings can make a difference. For example, by offsetting £2500 of savings against a £100,000 mortgage taken over 20 years, you could reduce your term by around seven months.

Here are some more key advantages of this unique type of home loan:

• Flexibility – so, you can choose to make lower monthly payments and still pay back your loan over the full term. Some borrowers drop their repayments in the early stages of homeownership when finances are often tight, with a view to increasing payments and reducing the term at a later date and getting the best of both worlds.
• Your offset savings will not earn interest so you have no tax to pay on them. But you’re still, effectively, getting a return from those savings by reducing the amount of interest you pay on your mortgage.
• With some lenders, you can link up to six savings accounts. There are also options to offset your mortgage against an ISA or current account.
• Offset mortgages allow you to access your savings at any point without having to remortgage.

As outlined above a straightforward offset mortgage has a number of key advantages, but there are other types available too, that bring their own distinct benefits, such as:

Family offset mortgage

With a family offset mortgage parents can use their own savings to help their children get onto the property ladder without giving them a deposit. The offset amount reduces the LTV and can help the buyer borrow more, reduce the interest rate they pay and pass their lenders’ affordability checks.

Buy-to-let offset mortgage

You can now offset a buy to let mortgage against savings as well. By opting for lower monthly payments, landlords can maximise their rental income. Or they can choose to reduce the term of their loan and their long-term borrowing costs.

What are the disadvantages?

When considering an offset mortgage, it’s important to factor the disadvantages into your decision, such as:

• Rates are generally higher than if you took the equivalent loan on repayment terms. This is partly because the market is quite limited
• Fewer lenders provide offset mortgages so just finding a provider can be a challenge
• You will need a fairly large deposit of at least 20% (25% with some lenders)
• Most providers who do offer this type of borrowing will insist that both your mortgage and savings are with them
• Although your savings remain accessible, you will need to bear in mind that making a withdrawal will lessen the benefits you receive using this type of mortgage
• Some providers will stipulate a minimum balance that must be kept in your linked savings account. There may also be minimum withdrawal amounts (typically £250)

Eligibility criteria

Criteria vary from one lender to the next, but the majority of the requirements are standard across any mortgage:

• Savings account – Most lenders require the account you intend to use as the offset facility to be held with them. It must be a personal account (not a limited company account) and some will have minimum balance requirements, but this could be as low as £100.
• Deposit – In many cases, you’ll need at least a 25% deposit for this type of mortgage. It’s possible to find a deal with a lower deposit requirement, however, these are largely reserved for those who already have a mortgage with the lender and are simply switching to an offset deal.
• Income/Affordability – This is generally used to determine your overall borrowing, which is based on a multiple of typically 4.5 times your expendable income.
• Employment type – Self-employed applicants may need to use a specialist broker, but products are readily available as long as proof of income can be provided. Some lenders even have contractor-specific offset mortgages.
• Credit rating – Specialist bad credit lenders are available if necessary, however, most high street lenders will require a good credit record.
• Age – Most, but not all, lenders cap their borrowing at 75-85 years of age, although there are specific offset products intended for older borrowers.
• Property type – Some lenders restrict their lending or refuse to lend on certain property types, this is typical if you plan to purchase a building of non-standard construction.

How much savings do you need?

The majority of lenders don’t have a minimum savings requirement, however, whether or not this type of mortgage will be beneficial to you will depend on your overall circumstances. In some cases as little as £2,500 could reduce the length of a 25-year term by up to 7 months, however, if you’re likely to need that money in the meantime, it’s unlikely that an offset mortgage will benefit you.

On the other hand, if your savings are greater than the mortgage balance, you would benefit from paying no interest throughout the duration of the mortgage, although some lenders have a maximum level of savings that can be linked to the loan.

In these circumstances, however, buying the property outright or using your savings as a larger deposit could offer greater benefits. The specialist brokers we work with will be able to go through the calculations with you and help you to decide whether you would be making optimal savings with this type of mortgage.

Work Out How Much Interest You Can Save

You can use our calculator below, based on your own specific circumstances, to see how much interest can be saved using an offset mortgage:

Offset mortgage or overpayment – which is the best option?

If you pay the full monthly amount of an offset mortgage, you are effectively overpaying every month. This can mean you clear your loan quicker and pay less interest overall.

Providers usually allow overpayments of up to 10% per year on a repayment mortgage without incurring any fees, and this can provide the same benefits.

However, if you choose to make overpayments on a standard mortgage, you cannot then simply ask for that money to be refunded. Accessing it will require you to remortgage, take out a secured loan or apply for equity release if you are eligible, all adding up in extra costs and time.

Likewise, offsetting your savings can lead to temptation that wouldn’t otherwise exist. You will need to be strict with yourself and not dip into them without proper consideration. If you do, you could undo all the benefits you thought you had gained.

Offset mortgages are often a good choice if you’re self-employed and have to keep large sums of money in your account to cover tax bills or other one-off expenses. This way, you retain liquidity but also make your savings work harder for you by reducing the interest you pay on your mortgage.

As always, you should seek the advice of a whole of market broker if considering this course of action to check whether it really is the most affordable way for you to borrow.

Remember, it’s important to consider not just your current situation, but also your future plans when deciding which mortgage is right for you.

Offset mortgage vs savings

If you’re paying a high rate on your mortgage but significant savings accruing minimal interest, an offset mortgage might be your best option.

Although you won’t earn any interest on your offset savings balance, it’s likely the savings you make on the borrowing cost of your mortgage will more than compensate.

And with interest earned via traditional savings accounts liable for tax, you will be making an extra saving there too. Remember, though, that you can invest up to £20,000 per year in a tax-free ISA.

To demonstrate the potential savings associated with offset mortgages, let’s take a look at one in action.

Imagine you take out a £200,000 mortgage at 2% interest and have £50,000 in a savings account paying 1.5%.

On standard repayment terms, the interest on your mortgage works out at £4000 per year. You would also earn £750 in interest from your savings account so your net cost between the two is £3250.

If you offset those savings against your mortgage, the interest is only calculated on £150,000 (your mortgage balance minus your offset savings balance). This equates to annual mortgage interest of £3000. You earn no interest on your savings but your net spend is still £250 lower than if you had left them where they were. This example assumes you make no withdrawals.

Over the term of your mortgage, those annual savings can easily amount to thousands – particularly if you continue adding to your offset savings, thus reducing the balance against which your interest is calculated. The only restriction on the amount you can put in your offset savings is that it mustn’t go above your mortgage balance.

Offset mortgage vs a larger deposit

In many cases, if you have a large amount of savings, it might be better to increase your deposit instead of using it to offset your mortgage.

This could reduce your loan-to-value and give you access to lower rates. Before deciding which is the best decision, it’s wise to calculate the total cost of borrowing according to each method. But keep in mind what you anticipate doing when your fixed rate comes to an end in either event, as that might have a significant bearing on which is the cheapest way to borrow in the long run.

What types of savings accounts can be used?

Most lenders accept a variety of account types and in many cases, you can link multiple accounts to one mortgage, including joint accounts, if both names are also on the mortgage. In the vast majority of cases, the account(s) will need to be with the lender, and aside from traditional savings accounts, could include:

ISA

Some lenders will let you use a cash ISA to offset your mortgage, so long as they are instant access accounts. Fixed-term ISAs and stocks and shares ISAs cannot typically be used for this purpose.

Current account (CAM)

Some lenders allow current accounts to be used to offset a mortgage. These are less common and often referred to as CAMs (current account mortgages). They differ from offset mortgages slightly, as the current account and mortgage are combined into a single account, rather than simply linking a separate savings account to your mortgage account.

Self-employed business account

If you’re a sole trader or contractor and the business account is in your name, it may be possible to use your business account to offset your mortgage, so long as it’s held with the lender.

Limited company account

If you’re purchasing a residential property, you won’t be able to use your limited company account to offset your mortgage. Because a limited company is classed as a separate entity, it’s illegal to use the funds held in its business account in this way, unless they are first drawn down to a personal account as salary, dividends, or a director’s loan.

There are specialist lenders who offer commercial offset mortgages, however, so you could potentially use a limited company account to offset the interest on a mortgage for your business premises.

Pension

It’s unlikely that you will be able to link this type of account to your offset mortgage, but if you’re at retirement age and looking for an offset product, the brokers we work with will be able to recommend something suitable.

Get matched with a specialist offset mortgage broker

Working out the best way of balancing your mortgage and savings is one of the biggest financial decisions you will ever make. And it will go a long way to determine how quickly you achieve financial freedom.

Offset mortgages are becoming more readily available but they remain a niche product. The brokers we work with have experience and knowledge in specialist borrowing models and, crucially, have whole of market access.

Our unique broker matching service will assess your needs and, if deemed the best move, pair you up with an expert offset mortgage broker to ensure you make the most of your borrowing and saving.

Call today on 0808 189 2301 or enquire online to arrange a free, no-obligation chat.