With offset mortgages, homeowners use the power of cash savings to pay less interest on their home loans. This type of mortgage is favourable for borrowers who have extra cash tucked away, especially at a time when banks are paying relatively low returns on deposits.
Offsetting can also be a quicker route to mortgage freedom, trimming months (or years) off the term of a home loan. Many people, however, remain unaware about the benefits of offset mortgages. Here’s how they work and why they might be suitable for you.
What’s an offset mortgage?
With an offset mortgage, a borrower’s savings are kept in an account that is linked to his or her mortgage arrangement. Rather than earning interest, the savings are used to reduce the interest being paid on the home loan.
The savings aren’t used to repay the mortgage, but sit alongside the arrangement. For example, if you have a mortgage worth £100,000, and savings worth £20,000, by offsetting you only pay interest on £80,000 of the debt. Monthly capital repayments, accounting for the original sum that’s been borrowed, continue to be paid back by the borrower under the terms of the offset deal.
What are the advantages?
Crucially, with offsetting, homeowners still have the flexibility to access their savings. But making a withdrawal has a ‘see-saw’ effect. If money is taken out, mortgage interest payments would go up, and vice versa.
It’s worth noting that flexibility comes at a cost. The interest rate applied to offset mortgage products tends to be higher than those on more traditional home loan arrangements.
Another advantage of offsetting, however, is that it allows customers the choice between paying back the amount they’ve borrowed over a shorter mortgage term, or making lower monthly payments.
Opting for this type of mortgage deal also means savings are being put to good use, but that money is not lost if a borrower needs to access it.
Deposits held in a linked offset savings account are also protected by the Financial Services Compensation Scheme. This compensates savers up to £85,000 per person, per institution, should a bank or building society fail.
Which borrowers best suit an offset mortgage?
Offset mortgages aren’t appropriate for everyone and tend to favour homeowners sitting on significant savings.
A typical offset mortgage customer will be financially secure in life and have a significant equity stake in their property. Would-be mortgage customers in line to receive a lump sum, from an inheritance for example, might also be tempted to consider this option.
Borrowers, however, who have earmarked savings for an imminent project or purchase, may be better off with a traditional mortgage if that surplus cash is due to be spent imminently.
Cash-poor first-time buyers aren’t likely to benefit from offset mortgages, either. These home loans can, however, be used by parents to help their children get onto the property ladder.
How do you get an offset mortgage?
By applying directly to a provider. Offset mortgages are less common than traditional home loans, so your choice of would-be lender is more limited.
Providers offering offset mortgages include the banking giant Barclays, Coventry and Yorkshire building societies, and the banking arm of life insurer and pensions provider Scottish Widows.
A mortgage broker can help you search the market as widely as possible. Brokers can also tell you if an offset mortgage is suitable for your circumstances, how they work, what the options are, and which lenders provide them.
Some brokers charge for their service, while others are fee-free and take a commission from the lender you pick instead. If you’re unclear how a broker is going to be paid, ask them to explain.
Are there different types of offset mortgage?
In essence, yes. As with traditional home loans, there are two main types: repayment, or interest-only. Repayment arrangements require customers to pay back the original sum that they’ve borrowed (the capital), plus the interest owed on top. In the case of an offset arrangement, the mortgage account is linked to your savings.
Interest-only mortgages are less common than they used to be. With these home loans, customers only pay the interest that’s owed, not the capital. Because of the nature of interest-only home loans, lenders require would-be borrowers to have a plan in place to repay the capital at the end of the mortgage term.
Interest-only customers still need to pass a lender’s affordability checks as if they were applying for a repayment deal.
Fixed-rate or variable?
As with standard mortgages, opting for the offset route means you can choose between deals offering either a fixed or variable interest rate.
Although interest payments can fluctuate depending on how much is in the savings element of the offset arrangement, with a fixed-rate the amount charged on that sum is static.
Variable rate deals usually track an economic indicator such as the Bank of England base rate, or relate to the lender’s own standard variable rate.
One of the key differences between offset mortgages and standard alternatives is the ability to access cash when it is needed. Standard mortgages usually allow borrowers to make limited overpayments each year, which also works to cut interest. However, if homeowners need that money back, they need to appeal to their lenders and undergo affordability checks.
What are the drawbacks?
Offset mortgages are not suitable for all homeowners because their flexibility comes at a price in the form of higher-than-normal interest rates. Plus, not all lenders offer them. When savings rates are good, customers won’t earn anything from deposits held in an offset-linked account. Some borrowers will fare better if they plough their savings into a traditional deal and secure a lower mortgage rate that way.
As with any mortgage arrangement, the important task is to do your sums before committing to any deal and weigh up which option suits your finances the best. Use online comparison tools and calculators to help your research.
Unless you’re sure you can leave your savings untouched and benefit by lowering your overall mortgage debt, an offset home loan might not be the right choice for you.