An offset mortgage basically uses the interest from your savings account against the interest charged on your mortgage. Usually your mortgage lender will link your mortgage and savings account into a single account, with the same financial institution. Each month, the amount you owe on your mortgage is reduced by the amount you have in your account, before working out the interest due on the mortgage. For example, if you had an offset mortgage of £100,000 and you had savings in your offset account of £25,000 you will only pay interest on £75,000. When your savings balance goes up, you pay less on your mortgage. If you continually keep your savings balance high, this could eventually result in your mortgage being paid of early. On the other hand, if your savings go down, you pay more on your mortgage. Your mortgage lender will plan with you the minimum amount you should leave in your account each month.
Offset mortgages are especially attractive for higher rate taxpayers who would otherwise be charged 40% tax on interest earnt on their savings. When the interest earnt on your savings is automatically used to offset your mortgage, you will not have to pay any tax on those saving. According to one major financial lender in the UK, they believe that 25% of existing mortgages holders would be better off with an offset mortgage.
Offset mortgages are also flexible without a penalty. You can make extra payments, under payments and have a break from payments as long as you have made sufficient overpayments over the years.
Not all offset mortgages are the same. The competition among lenders is increasing and as a consequence the borrower has more options to choose from. This can include: free property valuations and free legal work, using two nominated saving accounts to be offset, and additional borrowing facilities. Depending on your lender, the saving accounts of family members can be combined to offset against one person’s mortgage; this is a popular choice for parents who want to help their offspring purchase their first home.
There are some disadvantages to an offset mortgage. Most offset mortgages allow the borrower to have a credit limit; if you are not disciplined about paying this back, then at the end of your mortgage period, you could be left with a big loan to pay. Thus, it takes a lot of budgeting and self-control to ensure the current account mortgage works effectively. Interest rates are different for the current account, savings and mortgage, so you do not have the opportunity to save money at the Standard Variable Rate like you can do with a current account mortgage.
Offset mortgage originally started in Australia and are fairly new to the UK market, however they have quickly gained in popularity. Originally, mortgage lenders only targeted the wealthy but they have now widen the market for customers who are charged basic tax and have savings. As a rough guide, a basic taxpayer needs around £20,000 in savings behind a £100,000 mortgage to make the offset deal better than a traditional mortgage. For a higher rate taxpayer, the savings requirement is about £10,000 although those figures will change as interest rates vary. If you are looking for a mortgage, an offset mortgage is something to seriously consider, particularly if you are a higher rate taxpayer and/or have substantial savings to offset. While the basic concept of an offset mortgage is simple, it does get complicated. This clearly underlines the need to talk things through with a mortgage advisor. It is their job and responsibility to ensure you get the right type of mortgage and the best deal.