In this brief guide, we are going to discuss offset mortgages, the pros and cons of offset mortgages and if an offset mortgage is right for you.
What is an offset mortgage?
An offset mortgage is a mortgage whereby your savings are used to reduce the amount of interest you pay on your mortgage by offsetting your mortgage balance.
An offset mortgage works by linking a savings account to your offset mortgage.
Interest is charged on the difference between your mortgage capital balance and the savings in your offset savings account.
The more you deposit in the savings account the less in interest you have to pay.
You can withdraw the funds from your savings account at any time as there is no lock-in period. This will, of course, increase your interest payments for the month depending on how or when the amortization table is recalculated for your offset mortgage.
The funds in the linked account can be deposited by friends of family members, they do not have to be your own funds.
An offset mortgage can help you;
- Pay your mortgage off quicker
- Reduce your monthly payments now or in the future
How do offset mortgages work?
Offset mortgages work a bit different from traditional mortgages.
With traditional mortgages, your monthly mortgage repayments go toward paying off the capital borrowed and the monthly interest charges on your mortgage.
In the first few months, the interest charges on your mortgage are much higher, as you begin to pay down the capital owed, the interest repayments subsequently become smaller and smaller as interest is now being charged on a much smaller mortgage balance.
Your savings play not part with a traditional mortgage.
With an offset mortgage, your savings are linked to your mortgage account as they are held with the same mortgage lender and used to offset the mortgage balance.
This means they are used to reduce the mortgage balance on which you are charged interest.
This means your monthly interest charges are subsequently lower as you are being charged interest on a mich smaller mortgage balance.
This effectively means every monthly mortgage overpayment you make is an overpayment and will ensure you repay your mortgage balance much earlier than you would with a standard capital repayment mortgage.
An example of an offset mortgage:
If you have a £400,000 mortgage and £100,000 in savings. With an offset mortgage, your £100,000 linked savings will reduce your mortgage balance by £100,000.
This means your mortgage balance will be £300,000. This is the amount interest will be charged on and applied to your next monthly mortgage repayment.
This means you will be paying less in interest than you would have done on a standard capital repayment mortgage.
You will pay much more towards your capital each month and hence pay off your mortgage much sooner.
What does it mean to overpay your mortgage?
Overpaying your mortgage means you pay more on the capital owed on your mortgage than you would be required to by amortization schedule. This means you cut down on the amount of mortgage debt you will have been charged interest on in the future and essentially save yourself some amount in interest charges.
Most mortgage lenders will allow you to overpay your mortgage by 10% each year before they will apply any early repayment charges for overpaying your mortgage.
With an offset mortgage, you are essentially overpaying your mortgage as the savings in your offset account reduce the mortgage debt on which interest is charged on-this means each monthly mortgage repayment has a smaller interest charge than it would have usually done but a much bigger amount will now go towards capital repayment.
Is an offset mortgage right for you?
An offset mortgage will usually not pay you interest on your savings.
However, there are other benefits to an offset mortgage as it allows you to overpay your mortgage and in essence pay off our mortgage quicker.
You can get a fixed offset mortgage or a tracker rate.
You can repay the offset mortgage at any time but early repayment charges may apply.
An offset mortgage can be an incredibly cheaper way to get on the property ladder and allow you to pay off your mortgage quickly
Offset mortgages may be more suited for those who are higher rate taxpayers or receive a lot of their salary in large lump sums. If you are a higher rate taxpayer you may get the first £500 tax-free due to your personal savings allowance.
The pros and cons of offset mortgages
As with anything offset mortgages have various pros and cons and you should consider the pros and cons of offset mortgages before you choose to take out an offset mortgage.
The pros of offset mortgages
The pros of offset mortgages include:
- Offset mortgages allow you to reduce the amount of interest which you pay on your mortgage by increasing the amount of savings in the offset savings account. This means adding much more to your savings account could be beneficial.
- Offset mortgages may make getting a mortgage easier for so many first time buyers who may not be able to afford a mortgage deposit but could utilize savings from their family members
- An offset mortgage may mean you pay your mortgage balance much faster than with a standard mortgage
- Offset mortgages may have tax advantages- You may have to pay no tax on the interest you save – You may have to pay tax on interest earned on a normal savings account (apart from cash ISAs).
- You may be able to use an ISA account or a savings account to offset your mortgage balance
- You may still be able to access the savings in the linked offset account.
- The savings used for your offset savings account do not need to be your own funds, they could be gifted or borrowed from friends.
- Offset mortgages may be able to allow you to help your child or relative on to the property ladder.
The cons of offset mortgages
The cons of offset mortgages include:
- Your funds may not gain any interest when they are saved in an offset mortgage account.
- Due to the benefits of offset mortgages, you may need to pay a much higher mortgage rate.
- Offset mortgages are also quite limited and hence there won’t be much competition amongst mortgage lenders and this means higher mortgage rates for you.
- You will usually not be able to use an offset mortgage with any first-time buyer government scheme
- Another con of offset mortgages is that you may need to put down a much larger mortgage deposit of around 25%. Most mortgage lenders will offer loan to value rates of up to 75%.
- Not a lot of mortgage lenders offer offset mortgages and hence your choices may be quite limited.
- The linked savings account will usually need to be with the same mortgage lender. This means you won’t be able to benefit from better savings rates from other lenders.
- Your monthly mortgage repayments may rise if you make any withdrawals from your linked savings account.
- You may be able to get better interest savings and potential interest savings by simply using your savings towards a mortgage deposit.
- Not all offset mortgages offer savings accounts which pay interest in the savings.
- As your savings are not linked to inflation they may lose their spending power.
Should you get an offset mortgage or a capital repayment mortgage?
Your ability to decide between an offset mortgage or a capital repayment mortgage will mostly depend on if you can fund a mortgage deposit yourself or if you will need the help of your friends and family.
If you can fund the mortgage deposit yourself then you may want to consider getting a capital repayment mortgage as offset mortgages tend to have higher mortgage rates.
You will need to work out if the flexibility offered by the offset mortgage is much better than the cost of a repayment mortgage, regardless of if it is cheaper or much more expensive.
If you also qualify for any government scheme which could help you buy a property by increasing your mortgage deposit or reducing the price of the property then it is worth considering if that government scheme will make getting a capital repayment mortgage a much better choice.
You should also take into account the potential costs of any government schemes.
Some of the government schemes you may be able to use include:
- Lifetime ISA– gives you a government bonus of £1,000 if you save the maximum £4,000 a year.
- Help to buy ISA– gives a maximum bonus us £3,000 if you save the maximum allowed of £12,000. Before you get either you should consider which is better. Lifetime ISA vs Help to buy ISA.
- Help to buy equity loan- gives you up to 40% as a 5-year interest-free equity loan. You begin to pay interest at 1.75 % after the fifth year and 1% plus RPI for every year thereafter.
- Shared ownership– You can buy between 25% to 75% of the property initially with a shared ownership mortgage and then buy more using a staircasing mortgage.
- Armed forces help to buy– similar to the help to buy equity loan but specific for the armed forces personnel giving them an increased chance of acceptance.
- Rent to buy– This is the right to buy scheme on which this guide is currently discussing. A different marketing name is just used. Watch out for this when shopping to avoid missing out on eligible properties due to confusion.
- Right to buy– allows you to buy your home at a discount price.
- Preserved right to buy- same as above.
- Right to acquire- same as above.
Depending on where you live, you may also be able to take advantage of home buying schemes provided by your local council. Example: In Norwich, the local councils provide the Norwich home options scheme.
Your mortgage broker should help you consider this question in more detail.
What happens to the saving in your offset mortgage account?
Nothing happens to the offset savings in your offset savings mortgage account. You will usually not receive any interest on your savings but you also won’t have to pay any tax on it.
The amount of savings you have in an offset account is not used to repay the capital on your mortgage account except you specifically ask the mortgage lender to use it to make an overpayment.
Other factors to consider with offset mortgages
Some offset mortgage lenders will offer fixed-rate mortgage deals which lock you in for a few years. These deals may not be the most competitive on the market and you should carefully consider your mortgage options before signing up to this.
Other offset options
Offsetting your mortgage balance with your savings are not the only options you have when looking into offset mortgages.
You may also be able to get an offset mortgage by offsetting it with other investment options or assets such as shares.
You should speak to your mortgage broker about this.
Not all mortgage lenders allow you to save
Not all mortgage lenders allow your monthly mortgage repayments to go towards paying off a greater amount of capital if you are offsetting the capital balance on your mortgage and hence have reduced monthly interest charges.
The allure of offset mortgages to many borrowers is the fact that you ca essentially overpay your mortgage each month as the offset savings reduce your capital balance and hence the amount of interest you pay each month is reduced based on a new amortization table.
This means when you make your standard monthly mortgage repayment, it will mostly go towards capital repayment rather than interest charges however not all offset mortgage lenders allow this and this could mean that you are not fully benefitting from an offset mortgage.
You should speak to your mortgage broker to ensure that the offset mortgage you have fits your needs.
You need to pass affordability checks
Offset mortgages have affordability checks and these are not reduced because you are getting an offset mortgage.
You will still need to meet the mortgage lenders requirements in regards to your credit score, the amount you have to put into the offset savings account and the type of property you want to buy.
Can you get a buy to let offset mortgage?
Yes, buy to let offset mortgages are available but these mortgages may not offer much savings to landlords as they can no longer deduct interest payments from their tax bills. Buy to let mortgages may only help the landlord reduce their mortgage costs.
Can you get an offset remortgage?
Yes, you may be able to get an offset remortgage if you already have an offset mortgage hut keep in mind that there may be some hefty early repayment charges associated with your offset mortgage.
Current account mortgage vs offset mortgages.
Current account mortgages are mortgages which combined your mortgage debt and any savings in the same account.
A current account mortgage could include credit card debt, loan balances etc
A current account mortgage works similar to an offset mortgage in the fact that the savings in the account help reduce the interest you pay on your mortgage debt.
The main difference with a current account mortgage is that everything is in one account rather than in a linked account.
Alternatives to an offset mortgage
There aren’t that many alternatives to an offset mortgage but the key thing which attracts many borrowers to an offset mortgage is the fact that you are able to overpay on an offset mortgage and you can still access funds which you have previously overpaid with no fees.
If these are the most attractive elements of an offset mortgage then you may want to consider finding a mortgage lender who will allow you to overpay more than 10\5 of your mortgage per year with no fees but also allow you to draw down on any prior overpayments with no fees.
These are features you may find with a flexible mortgage.
You can use an offset mortgage calculator
You may be able to use an offset mortgage calculator to see how much an offset mortgage could cost you, how long it could take you to repay an offset mortgage and what the potential interest savings could be with an offset mortgage.
This offset mortgage calculator should be used for guidance only.
Using an offset mortgage broker
You may want to consider using an independent offset mortgage broker to get a mortgage.
Mortgage brokers are important as they can access mortgage products from across the whole of the market in some cases.
This could be over 11,000 mortgage products. This may have some advantages rather than going directly to a mortgage lender.
A mortgage broker will look to understand your financial circumstances and then provide recommendations on which mortgage products may be suitable for you based on your mortgage affordability.
After giving you these mortgage recommendations, most mortgage brokers will seek your consent to apply for a mortgage in principle.
This will allow you to shop for your home easier as more estate agents and sellers may take you seriously or it will give you confidence that your mortgage is indeed a possibility before you make a full mortgage application.
This will come with a key facts illustration document which details out the features of your mortgage including how much you will pay per month.
It will also contain information on if there are any limits such as early repayment fees, or annual overpayment limits.
If you are happy with everything you can then go on to secure your mortgage with the help of a conveyancer.
Your conveyancer will manage the legal searches on the property to ensure there aren’t any issues with it.
They will oversee the sales agreement to ensure it is in your best interest, they will manage the transfer of mortgage funds, exchange contracts with the seller or their conveyancer and set a completion date with the seller or their conveyancer.
In this brief guide, we discussed offset mortgages, the pros and cons of offset mortgages and if an offset mortgage is right for you.
If you have any questions or comments please let us know.