Should I get an offset mortgage?
If you’ve got cash in a savings account and it’s not earning much interest it could be more beneficial to offset it against your mortgage and reduce the amount of interest you pay. We explain off-set mortgages, examine the pros and cons and whether it's right for you.
What is an offset mortgage?
An offset mortgage is a mortgage which is linked to a savings account. The balance on these savings are then used to reduce the interest charged against the mortgage (thereby saving money). This is different to a ‘conventional’ mortgage in which interest is charged against the total borrowed amount.
The savings balance is not actually used to repay a mortgage but ‘sits’ alongside- essentially as a provisional ‘over payment’- while also allowing customers to dip into their account as and when the need arises.
How does an offset mortgage work in practice?
Let’s assume that you have taken out a mortgage for £200,000 at 3% interest, with £30,000 already tucked away in a savings account. By ‘offsetting’ these savings against the full mortgage amount, you will only actually have to pay interest on a total of £170,000. The interest rate on the total mortgage amount would equate to £6,000 per year; however, if we calculate the interest on the offset amount only it comes to £5,100, thereby representing an annual saving of £900.
If the savings had been left in an account paying 2% interest you would have earned £600; £300 less than the figure ‘earned’ from the mortgage. Remember, however, that if you choose to withdraw a sum of money from their linked savings or current account, then the repayment amount will increase proportionately.
How else can I benefit from an offset mortgage?
Aside from the annual savings, an offset mortgage will also offer customers the choice between paying back the borrowed amount over a shorter term or making lower monthly payments. This is because mortgage payments are based upon the full loan amount (as opposed to the offset amount), which means that borrowers are actually overpaying each month and thereby reducing the length of time it takes to pay off the total.
Depending upon the total offset savings amount, your mortgage term could be cut by months or, even, years. Alternatively, if you wish to save money in the short term, your lender may allow you to adhere to the standard terms of the mortgage, thereby reducing your monthly repayments.
What type of offset mortgages are there?
As with any ‘conventional’ package, offset mortgages are offered at both fixed and variable rates of interest, and should be chosen according to circumstances and the advice given by a mortgage broker.
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Are mortgage rates higher with an offset mortgage?
Typically speaking, rates for an offset mortgage are slightly higher than for a conventional mortgage (by on average 0.2-0.5%), although there has been something of a shift in the past few years.
It’s worth bearing in mind that some lenders will charge a higher rate of interest if you choose to reduce your monthly payments or pay back the mortgage quicker.
How can an offset mortgage help my children buy a home?
There are a few offset mortgage deals available which allow for parental savings to be offset against a child or family members mortgage- these are known as Family Offset Mortgages. Mortgages such as these work in exactly the same way as discussed above (with the mortgage holder subject to reduced interest payments in relation to offset savings) while allowing parents or grandparents to retain full control of the invested amount, thereby helping children to get their foot onto the property ladder without recourse to a large gifted sum of money.
The major disadvantage with this, however, is that parents will lose the interest on their savings for the duration of the mortgage and will not be able to get their money back until the mortgage has been paid to within 75-80% of the property value. For more ways to help your child buy a home read our guide on helping your children by a home
Is an offset mortgage for me?
Offset mortgages tend to be of particular value for higher rate or additional rate taxpayers, as well as for people with large savings who don’t rely on accrued interest to finance their day to day lives. The major advantage for high end taxpayers is that they do not have to pay tax on their savings interest. This means that they can avoid paying the 40-45% rate of income tax on earned interest by sinking their savings into an offset property.
As a general rule of thumb borrowers should have enough savings to cover at least 20-25% of their mortgage.
Summary of the pros and cons of off-set mortgages
- The interest saved will invariably exceed the amount that can be earned from a savings account.
- Enables borrowers to retain a flexible degree of access to savings.
- Borrowers may also be able to link their ISA accounts
- Allows for the possibility of paying off a loan at a quicker rate than with a standard mortgage or to make lower monthly payments.
- Enables parents to help their children buy a property of their own.
- Enables borrowers to reach the threshold in savings interest without having to pay tax.
- Borrowers will not earn interest on savings accounts that are linked to the mortgage.
- Payments on the mortgage may increase if the borrower makes a withdrawal from their offset savings.
- Mortgage rates can be higher.
- The Loan to Value (LTV) ratio is often lower for offset mortgages than conventional mortgages. In some cases, therefore, offset deals can require a deposit of up to 25% of the property value.
- In many cases the linked savings account and mortgage will need to be with the same provider.
- The offset market is minuscule in comparison to the wider market. This means that in some cases borrowers may find it harder to locate a deal or rate which is suitable for their needs.
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