Offset Mortgage Explained
Offset Mortgage Meaning
A mortgage where your savings account is linked directly to your mortgage loan. The key feature is that instead of earning interest on your savings, your money is used to reduce the amount of interest you pay on your mortgage. The savings account, however, must be held with the mortgage lender, not with your own bank or building society.
For example, if you have a mortgage of £500,000 and savings of £200,000, you’d only pay interest on £300,000 of your loan. This linkage can result in significant savings over the life of your mortgage and potentially reduce the term of your mortgage if set up to do so.
Flexibility of Offset Mortgages
These facilities offer impressive flexibility, as funds can be deposited and withdrawn whenever required. The offset account essentially provides instant access, behaving like a traditional savings account. You can use the savings for emergencies or future expenditures, like home improvements, without losing the mortgage-offset benefit until you spend the funds.
The Unique Benefits of Offset Mortgages
Self-employed Borrowers:
For self-employed individuals or some equity partners who often set aside funds for future tax bills, the mortgage allows these monies to reduce the mortgage cost until it’s time to pay the tax bill.
Future Home Improvements:
If you’re planning substantial home improvements, an offset mortgage allows you to start saving funds now, reducing your interest costs while you wait to initiate the work.
Large, Irregular Savings:
An offset mortgage can be particularly beneficial if you’ve received a lump-sum payment, such as an inheritance or bonus, which can be used to reduce the interest on your mortgage significantly.
Regular Savers:
The product rewards those with good saving habits. Regular deposits into the linked savings account help to continuously reduce the amount of mortgage debt that interest is charged on.
Higher Rate Tax Payers:
For higher-rate taxpayers, interest can be more tax-efficient than earning taxable savings interest.
Buy-To-Let Landlords:
Rental income received can be used to reduce mortgage interest, potentially resulting in substantial savings.
Retirees with Pension Pots:
Lump-sum pension pots can be used to offset the mortgage, reducing costs while ensuring the money remains accessible should it be needed.
Reduction of Term vs. Reduction of Payment Offset
When setting up an offset savings account, it’s essential to consider whether you want to reduce your mortgage term or your monthly payments. Both options have their distinct advantages.
Reduction of Term Offset:
Here, your monthly payment remains the same, but the term of your mortgage could be shortened. Essentially, you’re overpaying on your mortgage each month, which could help you to become mortgage-free sooner. This could save you a significant amount in interest payments over the long term.
Reduction of Payment Offset:
In this case, your mortgage term remains the same, but your monthly payment could be reduced. This could free up some extra money each month, which might be useful if your budget is tight or if you prefer to have more cash available for other spending or investments.
Offset Mortgage Interest Only
Many mortgage borrowers choose to take offset mortgages on an interest-only basis due to the flexibility and potential benefits this can provide. Here’s why:
Control over Repayments:
With an interest-only mortgage, your mandatory monthly repayments only cover the interest on the loan. This means they can be significantly lower than with a repayment mortgage. It allows borrowers to manage their monthly outgoings more flexibly.
Use of Savings:
The savings in the linked offset account can be used to reduce the overall mortgage debt over time. By maintaining a balance in your offset savings account, you are effectively reducing the mortgage balance on which interest is calculated. The more you have in savings, the less interest you pay.
Flexibility:
Borrowers can make voluntary repayments of capital at any time. This allows for a great deal of flexibility. For instance, if you come into a lump sum of money, you can use it to reduce your mortgage balance significantly.
Tax Efficiency:
For higher-rate taxpayers in the UK, there may be tax benefits to having an interest-only offset mortgage, as they won’t pay tax on interest they would have earned from their savings.
Long-term Planning:
Some borrowers have an expected lump sum on the horizon (e.g., maturing investments, pension lump sum, inheritance) that they intend to use to pay off the mortgage capital at the end of the term.
However, it’s important to note that interest-only mortgages, whether offset or not, come with a significant risk: at the end of the term, the borrower still owes the entire capital sum borrowed. The mortgage debt itself isn’t being reduced over time as it is with a repayment mortgage.
Therefore, a clear plan on how to repay the loan at the end of the term is crucial. As always, seeking professional financial advice is highly recommended.
Offset mortgage tax implications
there is no tax to pay on the savings in an offset account. That’s one of the advantages of an offset mortgage.
In the United Kingdom, with most savings accounts, any interest earned over your Personal Savings Allowance (PSA) is subject to tax. However, with an offset mortgage, you’re not actually earning interest on the savings – instead, you’re reducing the interest you pay on your mortgage. Therefore, the savings in the offset account are not subject to income tax.
This tax benefit can make offset mortgages a particularly appealing option for higher-rate and additional-rate taxpayers, who have a lower PSA and would therefore be taxed on a larger proportion of their savings interest if held in a traditional savings account.
As with all financial products, it’s always a good idea to discuss your individual circumstances with a financial advisor or mortgage professional before making any decisions. They can provide tailored advice based on your personal and financial situation.
Offset mortgage lenders
Offset mortgages are a more specialised type of mortgage product and are not offered by all lenders. In the UK, several lenders offer offset mortgages, including:
- Barclays: Barclays offers a range of offset mortgages with various interest rates, terms, and loan-to-value ratios.
- Scottish Widows Bank: This lender has a variety of offset mortgages available and are tailored to professionals and non-professionals.
- Coventry Building Society: Coventry offers offset mortgages with flexible features.
- Accord Mortgages: Accord has a range of offset products available.
- Coutts and other private banks: Private Banks can offer offset mortgages for large loans. These can also be arranged on non property assets or buy to let portfolios.
Remember that interest rates, terms, and availability may vary, and there may be additional lenders offering offset mortgages beyond this list. It’s important to receive advice and consider all your options before choosing a mortgage product. A mortgage broker can be a great resource in this process, as they can provide guidance based on your individual circumstances and financial situation.
Conclusion
Offset mortgages are a multifaceted financial product, providing benefits and flexibility for a wide range of borrowers.
However, while an offset mortgage has numerous potential benefits, it may not be the right product for everyone.
As with any financial product, it’s critical to seek professional advice and consider your personal circumstances before making a decision. Speak to an offset mortgage broker like Advias for further guidance and discover offset mortgage rates.
Author: Edward Checkley
Managing Director
