Types of mortgage
By Marie Kemplay
Article 6 of 10
Find out how offset mortgages work, who they're best for, and if they really can reduce the amount you pay.
What is an offset mortgage?
An offset mortgage is linked to one – or sometimes multiple – bank or savings accounts.
With a standard mortgage, your mortgage lender calculates the interest you owe based on the total amount you have borrowed. With an offset mortgage, the interest calculation is based on the total amount borrowed minus however much is held in the linked account(s).
For example, if you have an offset mortgage of £300,000 that is linked to a savings account containing £20,000, you would only pay interest on £280,000.
However, your mortgage payments would be calculated based on the full £300,000. Depending on the terms of your deal, this means you'd either overpay on your mortgage each month, therefore paying it off more quickly, or pay a smaller amount each month.
Over a full mortgage term this means you could potentially save thousands of pounds in mortgage interest payments - but do bear in mind you won't earn any interest on savings held in linked accounts.
Also, offset mortgages typically come with slightly higher interest rates than ordinary repayment mortgages, so if you have a relatively small amount of savings you may be able to save more money by simply shopping around for the lowest-rate mortgage deal you can get.
2.60%Average offset rate - January 2017
- Which? Mortgage Advisers can give impartial advice on whether an offset mortgage is the best option for you. Call 0808 252 7987 for a free consultation.
Pros of offset mortgages
- As you'll owe less in interest, you will effectively be 'overpaying' on your mortgage each month, which means you will pay it off quicker and save money on mortgage payments.
- Some lenders will allow you to reduce your monthly repayments based on how much you have in savings if you would prefer that to overpaying each month.
- You continue to have access to your money, in the event that you need it.
- Deals can be quite flexible – you can offset both savings and current accounts against your mortgage.
Cons of offset mortgages
- With most offset mortgages you won't earn interest on any cash held in accounts that are linked to the mortgage.
- Interest rates on offset mortgages are typically higher than those on comparable standard repayment mortgages (although offset mortgage rates are pretty competitive in the current market).
- Not many lenders offer offset mortgages, so your choice can be quite limited.
Is an offset mortgage for me?
When we surveyed 5,000 mortgage holders in April 2016, almost a quarter (23%) told us their mortgages were linked in some way to their bank account.
For an offset mortgage to really save you money, you would generally need a large pot of savings that you can afford to leave untouched in a linked account. However, in the current climate of low interest rates on savings accounts, offset mortgages could be worth considering for anyone looking to make the best use of their savings.
For example, let's assume you had a £200,000 mortgage and £5,000 in a linked savings account, meaning that you paid interest on £195,000 rather than the full £200,000.
If you had a mortgage charged at 3% interest over a 25-year term, you could pay off the mortgage about one year early and would save £5,439 in interest payments.
On the other hand, if you left the money in a savings account paying 1% (the best rate you can get on an instant-access account is currently a little less than this) for 25 years, you would only earn £1,419 in interest.
If you had £20,000 in savings, you'd only pay interest on £180,000 and could pay off the mortgage about two years early, saving £20,139. Leaving the money in an instant-access savings account at 1% for 25 years, meanwhile, would earn you £5,678 in interest.
Family offset mortgages
Offset mortgages can also be a way for people to help family members with mortgage costs by storing some of their savings in an offset account linked to a relative's mortgage.
- If you want to help your child or another family member get on the property ladder, check out our guide to family offset mortgages
Offset mortgages and tax
For higher-rate and additional-rate taxpayers in particular, offset mortgages come with the additional perk of being a tax-efficient way to use your savings. This is because you won't owe any tax on money you save on your mortgage payments by offsetting.
Conversely, if you're a basic-rate taxpayer and earn more than £1,000 a year in savings interest, or more than £500 for a higher-rate taxpayer, you will have to start paying income tax.
Income tax is 20% for basic-rate taxpayers and 40% for higher-rate taxpayers.
If you're an additional-rate taxpayer you will pay income tax of 45% on all savings interest.
- Read more about tax on savings
What is the difference between an offset and current account mortgage?
While an offset mortgage is linked to a separate bank account, a current account mortgage (CAM) combines your debts and savings into a single account where, like an offset mortgage, the savings you have reduce the interest payable on your debt.
CAMs can sometimes include balances for loans and credit cards as well as your mortgage.
- Last updated: January 2017
- Updated by: Dean Sobers