Mortgages come in many shapes, but one interesting option for borrowers who also have some cash savings is an offset mortgage.
To make effective use of an offset mortgage you need to have a savings, a current account and/or an Isa account with the mortgage lender. There are only a limited number of lenders who offer offset deals – including Barclays, First Direct and the Coventry and Yorkshire building societies – so that could mean moving your savings to your chosen provider, or, if you’re lucky, being able to set up an offset mortgage with the bank where you already hold your cash.
How Does it Work?
Instead of earning interest from your savings accounts, the money you have in the "linked" accounts (there can be more than one) are offset against the amount you have borrowed, so you only pay interest on the reduced amount.
An example:
If you and your partner each had a personal current account and also had a joint current account and joint savings account, all with the same bank, you could link the cash in those four pots - let’s say they totalled £25,000 – to your joint mortgage account.
If you had borrowed say £250,000 to buy a new home, you would only pay interest on around £225,000 of the debt each month.
Over the term of a mortgage that could save you thousands of pounds. Using the First Direct offset mortgage calculator, and based on the Yorkshire’s five-year fixed rate deal of 2.2% and the figures above, you’d save over £13,700 in interest over a 25-year term, or £46 a month.
You’d therefore effectively be overpaying each month. That means you could either reduce your monthly payment in line with the interest, or continue overpaying to whittle away at the outstanding capital and clear it months or even years earlier.
Offset mortgages are interest-only, so there’s no repayment element built in and you will need to provide evidence of a plan to cover the capital repayments.
This could involve a separate investment scheme such as a Stocks and Shares Isa or endowment policy, or regular or ad hoc repayments into the mortgage. The latter option also enables you to progressively reduce the amount of outstanding capital, and therefore the interest paid in total and the duration of the mortgage.
One useful feature of this type of mortgage is its inherent flexibility, in that your hard-saved cash is stashed in an easily accessible savings account rather than ploughed into the mortgage itself, but still serves to reduce your interest payments each month.
That means if you need to withdraw some savings, you can, but you will pay more interest each month as a result. In contrast, if you’d put all your savings into a conventional mortgage to reduce the capital, it would not be easy to get the money back out.
Is an Offset Mortgage Right for Me?
Offset mortgages are likely to be most suitable for those with a bigger savings pot, who can significantly reduce their monthly outgoings or (to save more over the mortgage term) overpay and reduce their debt more quickly.
Borrowers also need a decent amount of equity or a substantial deposit. The maximum loan to value on First Direct’s offset mortgages is 75%, in line with those of other providers. A spokesperson for First Direct adds: “An offset mortgage typically attracts home-movers or remortgage customers who have savings to help offset their interest payable each month.”
Offsetting can work well in tax terms too, particularly for higher-rate and additional-rate taxpayers. These borrowers don’t have to worry about breaching the tax threshold in savings interest (£500 for higher rate and zero for additional rate taxpayers) because their savings are not generating any interest. Although First Direct’s spokesperson observes, those savings “effectively perform at the same rate as their mortgage”.
What You Need to be Aware Of
Important to bear in mind is the fact that you won’t earn interest on savings held in linked accounts, so in some circumstances you might be better off keeping your money in a high-interest savings account and using a conventional mortgage. Though it's fair to say that these are few and far between at the time of writing.
Similarly, if you don’t have much spare cash in your linked accounts for any length of time, you might do better to find a cheap conventional mortgage deal, as offset interest rates tend to be marginally higher and make more sense if you have a reasonable amount of cash in your bank accounts to reduce interest payments.
It’s also worth considering how much you really want to keep in cash. While it’s always sensible to keep a fund for emergencies, it may be wiser to invest some in the stock market, for instance, where it may earn better returns over the long term.
Meanwhile, some buyers might do better to use their savings to boost their deposit, as a larger downpayment could give them access to deals with lower interest rates in the wider market.
In short, offset mortgages can be a great choice but they won’t work for everyone, and it may be sensible to talk to a mortgage broker before you commit to anything.
