What is an offset mortgage and how does it work?

Homeowners could benefit from an offset mortgage, where your savings account is linked to your mortgage.

One type of home loan that can get overlooked is the offset mortgage, but it can be a great option for many, including those with large saving pots. Since your mortgage is likely to be your biggest monthly outgoing, it’s important to get the best value loan in place.

It’s not just about snapping up the best mortgage rate. There are lots of different types of mortgages available and choosing the right one can be the key to smooth monthly finances.

Here we explain how an offset mortgage works and how to tell if it’s the right option for you.

What is an offset mortgage and how does it work?

This is a unique type of home loan, where your savings account is linked to your mortgage and the balance is offset against the debt. Interest is only charged on the difference.

So the bigger your savings pot, the more money you save on interest - and the quicker you pay off the loan.

Here’s an example of how it works.

If you had £10,000 in savings and offset it against a £150,000 25-year mortgage at 2.5%, you would save £8,170 in interest and see the mortgage repaid almost a year early, according to L&C Mortgages.

Offsetting £20,000 against the same mortgage would save £15,372 in interest and see the mortgage repaid 1 year and 9 months early.

Your savings don’t pay off any of your mortgage, so you still owe the money, but it will lower the overall cost of your loan.

Mark Harris, chief executive of mortgage broker SPF Private Clients, says: 'Offsets are not as popular as they should be, given the potential benefits. They work well for those with large stable amounts of cash on deposit; you would not be earning much in a savings account so can make your cash work harder by reducing the interest you pay on your mortgage.'

What’s the eligibility criteria for an offset mortgage?

A lender will assess affordability in the same way for an offset mortgage as for a regular home loan.

When applying, you will be subject to the same affordability criteria and the property the loan is secured against will go through the same checks.

The amount you intend to offset in savings won’t be factored into affordability calculations by the lender. You will need to prove that you can afford the mortgage and repayments if you had no savings linked to the loan.

This way they can avoid borrowers who try to use it as a route to securing a larger mortgage, use our mortgage calculator to see how much you could borrow.

Pros of an offset mortgage

Essentially, offset mortgages are a good strategy when savings rates are lower than mortgage rates.

Borrowers with decent savings can save hundreds of pounds of interest payments every year because the mortgage rate is higher than the savings rate.

Another plus is that the mortgage is paid off earlier as you pay less interest. It might only be a year or two as in our example above, but every month you shave off the length of the loan will be a welcome bonus when you get close to being mortgage-free.

The more you add to your savings pot, the further you will reduce the mortgage debt that you have to pay interest on.

You’ll have access to your savings whenever you need it.

Having an offset mortgage can also be a tax-efficient use of your savings, particularly for higher and additional-rate taxpayers, who pay more tax on any interest earned in a bank account.

They can also be a useful tool for the self-employed who can use an offset mortgage, rather than a self-employed mortgage, to make the most of savings they have put aside for their next tax bill.
If you receive a bonus you don’t plan to spend or you already have money in a low-interest savings account, then it often makes sense to open an offset account.

Cons of an offset mortgage

Offset loans are more expensive than standard loans. However, the margin today is much smaller with offsets priced closer to mainstream mortgages.

The Loan to Value (LTV) ratio is often lower for offset mortgages than conventional mortgages. It is possible to find loans that only require a 10% deposit, but they are few and far between. The overall availability is smaller than standard loans too, reducing choice.

Does an offset mortgage mean lower repayments?

The more savings you have in your offset account, the less you will pay in interest. Should you draw on your savings, your monthly repayments will be recalculated and will rise.

Can I still dip into my savings with an offset mortgage?

Offset mortgages offer instant access to your savings. This gives you peace of mind that if the boiler needs replacing or if you need a new set of tyres on the car, you can get to your money. Equally it can be drawn on to clear a tax bill, pay for a holiday or even school fees if that’s what the money is for.

Is an offset mortgage a good idea?

There’s no one-size-fits-all answer as to which mortgage type is best because everyone’s situation is different. For those lucky enough to have hefty savings, offset is a good option to explore.

David Hollingworth of L&C Mortgages says: 'With savings rates so low, offset deals are a solid proposition. Most people don’t think to explore this option, but it’s worth doing the sums if you have large savings in cash.'

'However, since rates on offset will typically be at slightly higher rates, it’s important to make use of the offset features.'

'If you just need a small amount of overpayment and have only a very small proportion of the mortgage amount in savings you may be better served with a more traditional deal.'

Indeed, you might prefer to take out a standard mortgage with a much cheaper rate and use a fixed rate savings account for some of your money with the rest in an easy access account. Do your sums to see which works best.

Equally, you should take a wider look at your finances. If you have expensive debts – perhaps a large amount owed on your credit card– clearing this can be a better use of cash savings than putting it on deposit, as rates on debt will be far higher.

Do all lenders offer offset mortgages?

Not all lenders offer offset home loans, so your choice of mortgage provider will be more limited than normal.

Some of those that provide offset mortgages are:

• Barclays
• First Direct
• Scottish Widows Bank
• Coventry Building Society
• Yorkshire Building Society

Mark Harris of SPF adds: 'Borrowers might feel put off by limited availability -and higher pricing - but it’s worth remembering that the effective interest rate paid could be much lower than that on a standard mortgage.'

How do I work out if an offset mortgage is for me?

You could be missing a trick if you don’t do your sums and work out how much you could be saving.

Many providers have offset mortgage calculators on their websites to let you play around with the numbers so you can see how it might work for you.

It can help enormously to use a mortgage broker if you’re unsure about the right deal for you or which lender to approach. Some brokers charge a fee whereas there are some that will arrange your mortgage fee-free. Make sure you understand their charges at the outset.