An offset mortgage is a mortgage that is linked to a bank account, usually a savings account. The money in your linked account isn’t used to make the mortgage payments, however is used to lower the amount of interest you will be charged per month and lowering your monthly payments. The balance in your savings account “offsets” the balance of the mortgage. The more cash in your savings account, the lower the monthly payments.
Here's an example of how an offset mortgage works:
If you take out a mortgage of £200,000 and you have £100,000 in savings, you can offset your savings account against the mortgage, which means you only pay interest on £100,000.
The interest rate is fixed at 4.5%. Instead of paying £9,000 a year in annual interest, you'll pay £4,500, saving £4,500 per year.
To get the total amount you'll save on your mortgage, you'll need to factor in the interest you don't earn on your savings. So if you were earning 1% on your £100,000, that's £1000 a year - which then means your true saving with an offset mortgage is £3,500.
There are three main options to choose from when selecting an offset mortgage:
- Reduce current mortgage repayments - with this option, the offset savings lower the monthly mortgage payments now, but the mortgage won’t be paid off any sooner.
- Reduce future mortgage repayments - here the offset savings are used to lower the monthly payments each year going forward, but the mortgage won’t be paid off any sooner. Every year the payment is recalculated, based on the reduced mortgage balance and the remaining mortgage term.
- Reduce the term of the mortgage - with this option, the offset savings are used to pay the mortgage off quicker. However, the monthly mortgage payments won’t reduce.
Anyone with a considerable amount of savings may be well served by an offset mortgage, which can result in lower monthly payments and the option of paying off your mortgage quicker.
Offset mortgages can be a good idea in several scenarios, for instance if you are self-employed and need to retain significant sums of money to pay for tax bills or unforeseen expenses. You still have access to your savings giving you flexibility should you have an imminent expense or purchase. You also won’t pay tax on the savings you make on interest charges, which could potentially save you money. You can also link a family member’s mortgage to your savings account, which is a good way to help a family member get on the property ladder, without incurring additional stamp duty charges as you won’t be on the deeds to the property.
It is important to note that the flexibility of an offset mortgage does usually come at a higher cost, interest rates are usually slightly higher than that of a standard mortgage product. You also won’t earn any savings interest on the amounts you have in your offset account. Putting down a larger deposit initially to lower your Loan To Value could make more sense, giving you access to lower rates and interest payments, although you won’t have access to the savings used.
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