Should I get an offset mortgage?

An offset mortgage links your current and savings account with your mortgage. While you won’t be earning any interest on those accounts, it could allow you to reduce your monthly payments or pay off your home loan sooner.

The total balances of your linked accounts are offset against the amount you owe on the mortgage each month. Your mortgage interest is then worked out on the lowered balance. 

Offset mortgages can be very helpful in certain financial situations but are not right for everyone.

This article will discuss:

• What is an offset mortgage?
• Is it better to overpay on my mortgage or offset?
• What are the best offset mortgage rates?
• How do you access your savings through an offset mortgage?
• How does a family offset mortgage work?
• What are the pros and cons of an offset mortgage?

If you’re looking for a new mortgage deal, check out our free mortgage comparison tool.

What is an offset mortgage?

An offset mortgage is a product that allows you to link two financial products that are usually separate: your mortgage and your savings account. Some banks may also include your current account balance.

Instead of earning interest on the money in your savings account, which may be taxable, you instead put your savings alongside your mortgage debt.

The interest you pay is on the outstanding mortgage minus the balance in your savings account.

Over time, this could also help you to pay your home loan off more quickly, if you keep monthly repayments the same. Or you could choose just to lower those payments.

Unlike a standard mortgage, which may allow you to make overpayments to reduce debt over time, with an offset mortgage your savings remain separate from your debt.

You can take the money out at any time, rather than having to request it back or remortgage to recover the money.

In some cases, the balance of your current account is also taken into consideration with your offset mortgage, meaning that you pay even less interest.

How much can I save with an offset mortgage?

The savings from an offset mortgage can be considerable. For example, if you have a mortgage of £250,000 but £50,000 in savings, you will only pay interest on £200,000 of your loan. 

This can save thousands of pounds over a typical 25-year mortgage term.

In this example from FirstDirect, a borrower who kept their £50,000 savings offset against their mortgage pot for the entire length of a mortgage would save almost £37,500 in interest over 25 years, assuming a two per cent mortgage rate.

Someone with a £25,000 savings balance would save almost £19,000.

Use an offset mortgage calculator

There are several calculators that will allow you to look at how much you might save with an offset mortgage.

This calculator from FirstDirect allows you to input your own details to see how much you would save.

Is it better to pay off my mortgage or offset?

With interest rates on the rise and mortgages getting more expensive, overpaying your mortgage might be something to consider now. It could save you thousands of pounds.

But savings rates are also on the rise, so only overpay if your rate you are paying on your mortgage is higher than the rate on your savings.

Most mortgage lenders allow you to clear a certain amount (often 10%) of your loan every year without being liable for an early-repayment charge.

Meanwhile you can choose to reduce the length of your home loan or the monthly payments when you do this. Some allow even greater flexibility.

The faster you pay off your mortgage, the better off you are likely to be in the long run.

What to consider before overpaying your mortgage?

Before you decide to overpay your mortgage there are things that you need to consider first:

• Is there an overpayment charge? Work out how much you can overpay so you aren’t caught out
• Do you have expensive debt? Pay this off first as the amount you will be charged in interest on your debt is likely to be more than any savings you make by paying your home loan off early.
• Do you have an emergency savings pot? Before you commit your spare cash to paying off your home loan, make sure you have sufficient ready cash should something happen such as you lose your job or the boiler breaks. Three to six months essential outgoings is the recommendation.

Pros and cons of offset mortgages

An offset mortgage gives you more flexibility, because the savings account is not used to repay the mortgage. The two just sit alongside each other, with the savings balance offsetting the outstanding home loan.

You may pay for this flexibility as offset mortgage rates are usually higher.

As always, no one product is right for everyone and whether or not you should use spare money to pay off or offset a mortgage depends on you and your individual situation.

For example, if you are self-employed and typically have to keep a lot of money to pay tax bills, or as an emergency fund because you have a volatile income, an offset mortgage means your money can work hard for you in reducing that debt until the moment when you need it.

Overpaying the mortgage would be a less suitable decision in this situation as you would not be able to get hold of the money at a time of your choosing.

On the other hand, if you have a highly stable job with lots of income but a high mortgage rate, putting spare savings towards overpaying the home loan could save you more money in the long run.

This is because rates on more conventional mortgages tend to be slightly lower so you will pay less overall than with an offset.

Offset mortgages aren’t for everyone and there may be a better choice for you, so consider your options carefully. If you are unsure, it might be best to speak to a mortgage broker.

Pros

• Potential to pay off your mortgage early or reduce monthly outgoings
• You have access to your savings if you need them
• No tax to pay on your savings, as you are reducing your debt instead of earning interest

Cons

• Interest rates can be higher than ordinary mortgages
• You will lose out on cash interest on your savings
• There are only a few offset mortgage providers so you might find it hard to find one to suit you

Can you access your savings with an offset mortgage?

One of the biggest advantages of an offset mortgage is that you can access your savings when you need them, which is easier and cheaper than remortgaging to get the money back.

If you make withdrawals, though, it will affect your mortgage.

Most offset mortgage lenders give you the choice to use your savings to shorten your mortgage term (so you pay it off sooner) or reduce monthly repayments.

If you withdraw your cash — so bringing down the balance in your savings account — either your monthly payments will rise or it will take longer to pay off the mortgage (costing you more in the long run).

Are offset mortgages tax efficient?

When you take out an offset mortgage, you forgo interest on your savings account.

But this may work in your favour given that current savings rates tend to be far lower than mortgage rates.

So the loss on what you earn is more than offset by the money you can make back in lower repayments or a shorter mortgage term. 

And then there is tax. You will pay tax on any savings interest over £1,000, if you are a basic-rate taxpayer, and over £500 if you are a higher-rate taxpayer. An offset mortgage can take you out of this tax trap.

However, if you can put your savings in an ISA — the annual allowance for contributions is £20,000 — you will not have to pay tax on the interest you earn.

This means that an offset mortgage is less efficient by comparison if you have other options such as those discussed above.

If you are buying your first home, check out our guide for everything you need to know.

Family offset mortgages

Some mortgage lenders allow other family members to set their savings against your mortgage debt. This can be a way for parents to help their children onto the property ladder.

By doing this, parents may forfeit interest on their savings. But it allows their children to buy a first home without gifting them a deposit.

Some lenders now also allow offset mortgage deals on buy-to-let properties.

This is now more relevant for landlords, as HMRC no longer allows you to deduct interest payments from the tax they pay on their rental receipts.

Finding a mortgage lender

If you decide an offset mortgage is right for you, you will want to find the best offset mortgage deal for you.

An independent broker may be able to help you with offset mortgage rates, and will even be able to help with more complicated an unusual products such as an offset buy to let mortgage.

The best offset mortgage for different types of people will differ. So it is important to do an offset mortgage comparison, even if you are convinced this is the right product for you.

You will also need to compare the the savings rates you would receive from an offset mortgage to the interest you would receive if you simply put your money into the bank.

If you want to know more about how to find the best mortgage lender, see this article.