Offset mortgages

What is an offset mortgage?

An offset mortgage is a home loan where savings held in a linked bank account are subtracted from the amount of mortgage that you pay interest on, meaning you can either pay less each month or pay off your mortgage more quickly.

For example, if you have £20,000 in a savings account that's linked to an offset mortgage of £300,000, you would only pay interest on £280,000.

This differs from a standard mortgage, where your interest payments are based on the total amount you owe. Over a full mortgage term, this means an offset mortgage could save you thousands of pounds in mortgage interest payments.

Keep in mind, though, that your capital repayments are still based on the full loan amount - the offset arrangement reduces the amount that you need to pay interest on, but not the loan itself, which will still need to be repaid in full.

Offset mortgages can also come with slightly higher interest rates than ordinary repayment mortgages, which might undo some of the benefits of offsetting. If you have a relatively small amount of savings, you might save more money by searching instead for the lowest-rate mortgage deal available to you.

You normally won't earn any interest on money held in linked accounts - so, depending on how much you have and what rates are available, you might sometimes be better off keeping your money in a high-interest savings account instead.

• Find out more: finding the best mortgage deal

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Can you access your savings with an offset mortgage?

One of the biggest advantages of choosing an offset mortgage rather than putting everything you have into your property deposit is that you can access the cash when you need it (although some lenders may require you to keep a minimum balance). This can be quicker and easier than remortgaging to release cash from a standard repayment mortgage.

Of course, if you make a withdrawal, that money will no longer offset your mortgage and so your repayments will go up.

For example, if you still owed £250,000 on a mortgage linked to an account containing £20,000, you would only pay interest on £230,000 - but if you withdrew £10,000, you would then start paying interest on £240,000.

If you have little or no money in your linked accounts for a long period of time, it may be worth considering switching to a different type of mortgage.

Should you put down a bigger deposit instead of offsetting?

There isn't a simple answer to this question. Putting down a bigger deposit will lower the loan-to-value ratio (LTV) you're borrowing at, which can mean that you get offered better rates by banks.

Keeping some savings back and placing them in an account linked to an offset mortgage would mean you'd be paying interest on a smaller sum, but it would also mean that you'd have access to the cash if you needed it. This is a more flexible option which is worth bearing in mind if you think you might need cash for a major project such as home renovation.

• Find out more: how much deposit do you need for a mortgage?

Offsetting vs overpaying: an example

For an offset mortgage to really save you money, you'll generally need a large amount of cash that you can afford to leave untouched in a linked account.

For example, let's assume you take out a £200,000 mortgage for 25 years with a 3% interest rate, and you also have £5,000 in savings. You take out an offset mortgage and place the £5,000 in a linked savings account, paying interest on £195,000 of the mortgage.

In this scenario, you'd save £5,440 in interest if you used the offset balance to help you pay off your mortgage in a shorter space of time, or £3,740 if you kept your mortgage term the same and instead made lower monthly payments (see table below).

However, with £20,000, your options are more interesting: by keeping the entire sum in an account linked to an offset mortgage, you'd save an impressive £20,150 in interest if you chose to pay off your mortgage more quickly, or £14,540 if you chose to reduce your monthly payments. Either way, you'd make a big saving and still be left with £20,000 at the end of the mortgage term.

Making a £20,000 mortgage overpayment, meanwhile, would save you £20,155 in interest and clear down £20,000 of your mortgage debt but leave you with no savings.

Leaving £20,000 in an instant-access savings account paying 1% for 25 years would earn you a paltry £5,678 in interest.

Sources: Family Building Society's offset mortgage calculator; Santander's mortgage overpayment calculator

Are offset mortgages tax-efficient?

For higher-rate and additional-rate taxpayers in particular, offset mortgages can be a tax-efficient way to use your savings.

You won't pay any tax on savings income, or use up your Personal Savings Allowance, because you won't be earning interest on your cash.

Your savings will still be generating a return - by bringing down your interest payments - but you won't face a tax bill.

• Find out more: tax on savings interest

Family offset mortgages

Offset mortgages can also be a way for parents to help children onto the property ladder, as they enable the parent to put savings in an offset account linked to their child's mortgage.

This means that the child's interest payments will be smaller, potentially making it easier for them to pass the lender's affordability checks.

Pros and cons of offset mortgages

Pros

• The reduced interest charges mean you can either pay the same amount each month and clear your mortgage quicker, or pay less each month.
• You can still access your savings if you need to make withdrawals.
• Offset mortgages can be tax-efficient if you're a higher- or additional-rate taxpayer.
• Offset mortgages will often allow you to make overpayments, though early repayment charges may apply.

Cons

• Interest rates on offset mortgages can be higher than comparable standard repayment mortgages.
• You normally won't earn interest on any cash held in accounts linked to the mortgage.
• Not many lenders offer offset mortgages, so your choice can be limited.
• Depending on the deals available, you may be better off using the savings you would have put into a linked account to pay down the mortgage itself.

Current account mortgages (CAMs)

You might occasionally hear people talking about current account mortgages (CAMs), although they're very rare in the current market.

While an offset mortgage is linked to a separate bank account, a current account mortgage (CAM) combines your debts and savings into a single account. CAMs can sometimes include balances for loans and credit cards as well as your mortgage.

Like an offset mortgage, the savings you have reduce the interest payable on your debt.