You may have heard the term offset mortgage while researching mortgage deals but what exactly does it mean?
This guide introduces the offset mortgage concept, explains how they work, who could benefit and gives an example offset mortgage breakdown.
What is an offset mortgage?
An offset mortgage is a type of mortgage linked to one, or more, savings account. The balance of the linked account(s) is used to either reduce your monthly repayments or your mortgage term.
How does an offset mortgage work?
You pay interest on the balance of your mortgage minus the balance of your savings account(s). You usually won’t earn interest on your savings, instead opting to save money on your mortgage interest repayments.
In most offset mortgages, only the interest payments take your savings balance into account. Repayments on the mortgage itself will most likely be calculated on the full amount. It is worth asking your lender about this, as it will vary.
What are the benefits of an offset mortgage?
Offset mortgages reflect a good balance between getting the most cost-effective mortgage deal and having access to a nest egg in case your financial circumstances change.
With a traditional mortgage you can make overpayments if you have more money than usual, but if things change again and you find yourself feeling the pinch, you can no longer access this overpaid money.
With an offset mortgage this problem is avoided as you have unrestricted access to the money in your savings account(s), although be aware that some lenders stipulate a minimum savings balance. You can withdraw money when needed, but keep in mind this will reduce the amount you save on interest repayments.
You are also able to add to the savings balance, further reducing the amount you pay in interest.
In most cases, you will save more money on interest repayments than you would earn from interest on the equivalent savings amount. An example is shown at the end of this guide. You also avoid paying any tax that would’ve been due on personal savings.
Used correctly, an offset mortgage can reduce monthly repayments or your mortgage term. We would usually recommend the latter if possible.
Who benefits most from an offset mortgage?
In our experience, offset mortgages are less popular among first-time buyers. They represent a relatively small section of the mortgage market, although they are increasing in popularity over the past few years.
We also see parents who want to give financial help to their children recommending offset mortgages, as their savings account can be linked to their child’s mortgage. This allows financial support without actually handing over a lump sum of money.
An offset mortgage example
This example uses simplified figures, but gives a general idea of how an offset mortgage could save you money.
- Say you had a £150,000 mortgage and £30,000 savings.
- You would pay interest on £120,000: the balance of the mortgage minus the balance of the savings.
- With a 3% rate this would cost you £3,600 in interest per year, rather than £4,500.
- If you previously had 1% interest on your savings account, you would miss out on £300 of savings interest.
- Overall, you pay £3,600 instead of paying £4,500 while missing out on £300, meaning you’re £600 better off at the end of the year.