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Understanding Offset Mortgages
If you’re thinking about taking out a mortgage and have some savings tucked away, you might be considering an offset mortgage. This type of mortgage can help you save on your monthly payments or even help you pay off your mortgage faster.
Currently, interest rates are on the rise in the UK, and that means higher mortgage rates. The good news is that savings rates are also up. An offset mortgage lets you use your savings to lower the amount you owe on your mortgage.
What is an offset mortgage?
An offset mortgage links to a savings account. The money in your savings account is used to reduce or “offset” the interest you owe on your mortgage, which can save you money.
With a regular mortgage, you pay interest on the entire loan amount. However, with an offset mortgage, you don’t directly pay off your mortgage with your savings. Instead, your savings balance sits there alongside your mortgage. But how does an offset mortgage work exactly?
How do offset mortgages work?
With an offset mortgage, the money you have saved is treated as a credit against your mortgage, kind of like an overpayment. This credit (the value of these savings) is then used to offset the balance of your mortgage.
For example, say you have a £200,000 mortgage and £20,000 in savings. With an offset mortgage, your £20,000 in your linked savings will be used to reduce your mortgage balance, making the amount you owe £180,000.
This means that you will only be required to pay interest on £180,000, which is the full mortgage balance minus the amount you have in savings.
Can You Access Your Savings With an Offset Mortgage?
With an offset mortgage, you have a unique advantage – access to your savings when you need them. This can be a real time-saver compared to the process of releasing cash from a standard repayment mortgage through remortgaging. However, be aware that some lenders might ask you to maintain a minimum balance in your account.
If we take the earlier example of having a £200,000 mortgage and £20,000 in savings, you would only be paying interest on £180,000. However, if you decide to take out a withdrawal, say of £5,000, your repayments will go up because you would now be required to pay interest on the new balance, in this case £185,000.
It’s a bit of a give-and-take situation. Your savings can help reduce the interest you pay, but if you dip into them, you’ll pay more interest.
The Pros and Cons of an Offset Mortgage
The benefits
- Reduced interest charges: Offset mortgages decrease your interest costs, giving you room to either cut your monthly repayments or clear your mortgage faster.
- Bigger savings: Your savings work harder in an offset mortgage compared to a regular savings account, typically outweighing what you’d earn in today’s low-rate environment.
- Tax efficiency: Your savings won’t be taxed, which can be helpful if you’re in a higher tax bracket.
- Access to your savings: You can still tap into your savings when needed.
- Adding funds: You can top up your savings account to increase the amount offsetting your mortgage interest.
- Early mortgage freedom: These mortgages generally allow overpayments, helping you clear your mortgage faster.
- Multiple account linking: Some lenders let you link additional accounts, such as your current account.
The drawbacks
- Slightly higher interest rates: Offset mortgage deals may come with a slightly higher interest rate compared to standard mortgages.
- No interest on your savings: Your savings accounts won’t earn any interest in an offset account.
- Withdrawals impact: If you withdraw from your savings, the amount offsetting your mortgage decreases, leading to higher interest payments.
- Minimum balance requirement: Some lenders may require you to maintain a minimum balance in your savings account, potentially limiting your access to your funds.
- Fewer options: Fewer lenders offer offset mortgages, which can mean fewer choices compared to standard mortgages.
- Higher deposit: Be prepared for a higher initial deposit, usually around 25%.
Is an Offset Mortgage Right for Me? – What to Consider Before Deciding
Should you get an offset mortgage? The answer comes down to your unique situation and what you require from a mortgage.
Income and savings considerations
If you have substantial savings and want to use them wisely, an offset mortgage is worth considering. It can lead to lower monthly interest payments or help you pay off your mortgage faster. You’ll likely save more on reduced interest payments than you would earn from a regular savings account.
However, if you frequently dip into your savings, an offset mortgage might not be the best fit. Each withdrawal reduces the amount that offsets your mortgage, increasing the interest.
Tax considerations
If you’re a higher-rate taxpayer, an offset mortgage can be a tax-efficient choice. Your Personal Savings Allowance (PSA) allows tax-free earnings of up to £500 in interest on your regular savings. However, your linked savings account won’t earn interest, so you won’t have to pay tax on your savings interest.
If you’re an additional rate taxpayer, the PSA does not apply to you, so you don’t enjoy any tax benefits with standard savings. However, with an offset mortgage, your savings also don’t earn interest.
FAQs
What is a family offset mortgage?
Family offset mortgages are designed to help first-time homebuyers with the support of a family member. It works by connecting your mortgage to a family member’s savings account, which lowers the interest you pay on your mortgage.
How much can you borrow with an offset mortgage?
The amount you can borrow with an offset mortgage varies from lender to lender and mainly depends on your personal financial situation. Lenders assess your income, expenses, and your ability to make future payments, especially if interest rates increase.
Sources:
https://www.nerdwallet.com/uk/mortgages/offset-mortgage-definition/
https://www.trinityfinance.co.uk/offset/
https://www.bankrate.com/uk/mortgages/offset-mortgages/#how-to-find-the-best-offset-mortgage-deal