What are offset mortgages, and how do they work?

If you’re wondering what are offset mortgages, they are a combination of a property loan and a savings account linked to it. The money you have saved is used to reduce the balance you pay interest on each month.

This type of mortgage should not be confused with an interest-only mortgage. You still have to make monthly payments to reduce the outstanding loan balance.

However, interest is calculated taking into account any savings you have in the linked account.

How does an offset mortgage work?

To better understand what are offset mortgages, let’s compare a typical repayment mortgage with an offset mortgage.

With a repayment mortgage, you borrow a lump sum and make monthly payments to repay the loan. Interest is also added calculated on the outstanding balance.

With an offset mortgage, any savings will be treated like credit on your mortgage. As such, the savings are used to offset the balance on which interest is calculated.

For example, if you were to borrow £200,000 and have £75,000 in linked savings. You would pay interest on £125,000. However, it is important to remember that the savings are only used to offset the interest you pay. The loan will still need to be repaid in full.

Benefits of an offset mortgage

Reducing the interest you pay is the principal benefit. With a reasonable amount in savings, you will be paying less interest on your loan.

A big reason to understand what are offset mortgages is that some lenders may allow you to put down a smaller deposit.. Thus, you can avoid tying up your capital in property.

You will have access to your savings, however, any monies withdrawn, will reduce the amount that can be offset against interest.

Because your savings do not earn interest, they will not count towards your personal savings allowance. So, although they do not earn interest, they save you interest, and as such, it is a tax benefit.

Disadvantages of an offset mortgage

You would think that by offsetting your savings, an offset mortgage would be a guaranteed saver on interest. However, this is not always the case.

While researching what are offset mortgages, it’s worth noting they tend to attract higher interest rates, which may reduce potential savings.

On the other hand, if you put the cash into a property, you will have a lower loan-to-value ratio. This, in turn, may help you access better deals.

Also, consideration should be given to savings rates. You may be able to access a savings rate which will generate a greater return than you can save by offsetting.

When opting for an offset mortgage, the linked savings must be with the same provider as the loan. As such, if you re-mortgage with a different lender, you will also have to move your savings.

You may also be limited in choice, as fewer deals are available, and you may have to pay high fees. If this is the case, these fees must be considered when calculating overall savings.

Are there different types of offset mortgages?

There are two main types of offset mortgages.

Family offset mortgage

These are typically used by people looking to help family members get on the property ladder. A parent may have savings that they can link to their child's mortgage account.

This would then be used to reduce their monthly interest payments. This facility can help first-time buyers be accepted by lenders.

Buy–to–let offset mortgages

Landlords can use these to reduce their monthly outgoings and increase their profit margins.

Is it better to use the cash as a deposit?

By paying a larger deposit, you will have access to better deals. However, by keeping the money in a linked savings account, you will pay interest on a smaller amount.

When comparing whether to use savings as a deposit or offset, understanding what are offset mortgages will help you decide which is most cost-effective.

As a rule of thumb, an offset mortgage would be worthwhile if you had between 20% and 25% of the mortgage amount in linked savings.

Is it better to overpay rather than offset?

There are normally limits to how much you can overpay without incurring early repayment charges. These need to be considered when calculating any potential savings.

Also, if you overpay, you can no longer access the cash.

With an offset mortgage, there is no limit on how much you can keep in savings. However, you may pay higher interest rates and fees, so there is a lot to consider.

Is an offset mortgage right for me?

Knowing what are offset mortgages helps determine if they’re suitable, especially for those with high savings. This is assuming that they do not need to access for a number of years.

The following situations are where they may work best:

Parents who want to help their children or other family members get on the property ladder. They can do this without having their money tied up in the property.

People who may want to access their savings.

Higher rate taxpayers who want to avoid paying higher tax on their savings.

Whether or not an offset mortgage is right for you will depend on how much flexibility you want for your savings. Also, how much such an arrangement could save or lose you.

Get mortgage advice

Whilst an offset mortgage will be suitable for some, it won't for others. Calculating potential savings and costs is an essential part of making the right decision. Seeking advice from a regulated advisor will help you through the process. 

Let Regulated Advice match you with a mortgage advisor for expert advice.