An offset mortgage is a home loan where savings held in a linked bank account are subtracted from the amount of mortgage that you pay interest on, meaning you can either pay less each month or pay off your mortgage more quickly.
An offset mortgage differs from a standard mortgage, where your interest payments are based on the total amount you owe. Over a full mortgage term, this means an offset mortgage could potentially save you thousands of pounds in mortgage interest payments.
What can an offset mortgage do for you?
A capital and repayment mortgage is a term generally used in the UK to describe a mortgage in which the monthly repayments consist of repaying the capital amount borrowed as well as the accrued interest.
Savers don’t enjoy much return on their cash. Last year’s base rate rise to 0.75% should have been good news for savers, but the actual rates offered by banks and building societies are still low and struggling to match inflation.
This means money left in instant access cash savings accounts simply falls in real value.
An offset mortgage can let you use your savings in a more rewarding way. It lets you leverage your savings to pay less interest on you mortgage payments.
With an offset mortgage you link your savings, and sometimes your current account, to your mortgage. Instead of earning interest, your savings are offset against your loan balance. You pay interest on the difference.
This can work in two ways. Some lenders will reduce your monthly payments to reflect the smaller debt, cutting your monthly outgoings.
Or alternatively, you could continue to make your full monthly payments. This should mean that you end up clearing your mortgage sooner.
Either way, you could potentially save thousands of pounds. Although your savings no longer grow, because the interest is used to pay towards your mortgage, you are getting a return on them equivalent to your mortgage interest rate.
This will almost certainly be substantially more than you could have made by the more conventional solution of depositing your £40,000 cash in a typical savings account.
Keep in mind, though, that your capital repayments are still based on the full loan amount – the offset arrangement reduces the amount that you need to pay interest on, but not the loan itself, which will still need to be repaid in full.
Offset mortgages can also come with slightly higher interest rates than ordinary repayment mortgages, which might undo some of the benefits of offsetting. If you have a relatively small amount of savings, you might save more money by searching instead for the lowest-rate mortgage deal available to you.
Why not just pay off the mortgage with your savings?
You could of course use the savings to pay off part of your mortgage, but that would mean that you no longer had your savings. By keeping them intact and using them to help pay off the interest on your mortgage, you have them to call on at any time you need them. Your mortgage payment would simply rise to compensate.
This works both ways – if you found that you were able to save more money, you could use it to reduce your mortgage payments still further.
What about tax?
There could be some tax advantages with an offset mortgage too.
For higher-rate and additional-rate taxpayers in particular, offset mortgages can be a tax-efficient way to use your savings.
You won’t pay any tax on savings income, or use up your Personal Savings Allowance, because you won’t be earning interest on your cash.
Your savings will still be generating a return – by bringing down your interest payments – but you won’t face a tax bill.
Could an offset mortgage work for you? To talk to a mortgage advisor, call us at Continuum.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action.
Your home may be repossessed if you do not keep up repayments on your mortgage.
The Financial Conduct Authority does not regulate taxation advice.