Offsetting your savings against your mortgage will reduce the amount of interest you pay. We explain how offset mortgages work, who they’re suitable for and the different types available in this guide.
Offset Mortgage Explained
You pay interest whenever you take out a mortgage, but the way interest is calculated for an offset mortgage is a little different from a normal one.
Normal Mortgage
With a normal mortgage, the lender calculates your interest by applying the interest rate to the amount outstanding on your mortgage. They usually do this on a daily basis, but you make interest payments monthly.
If you have a normal interest-only mortgage, your monthly payment is just the interest payment itself. The amount outstanding on your mortgage stays the same - until you repay it either at the end of the mortgage term or earlier if you can.
If you have a normal repayment mortgage, the lender adds together your capital payment – the amount that goes towards your mortgage balance – and your interest for that month to make up your full monthly payment.
Offset Mortgage
With a flexible offset mortgage, the lender sets up a current/savings account for you. They then link this offset account to your mortgage. These current/savings accounts do not accrue any interest but can make significant savings when offset against your mortgage balance.
Offsetting your savings against your mortgage balance is essentially a fancy way of describing the process by which the lender deducts any savings you have in the mortgage offset account from the amount outstanding on your mortgage. They call this remaining amount your “net balance”.
The lender charges interest on your net balance - not the total outstanding balance. They do this on a daily basis.
The main thing to remember is: the more you have in the linked savings account, the less interest will be charged for the time that it’s in there.
You can also take your money out of the linked savings account at any time or for any reason, or you can add to it via lump sums or - with most lenders - via regular monthly payments.
Who Are Offsets Suitable for?
- People with significant savings who may need access to them
- Higher and additional rate tax payers who could benefit from paying no interest on savings
- People who want to do home improvements
- People who save all year to pay for school fees or a tax bill
- People who want to save regularly to reduce their mortgage but not lose control of those savings
Types of Offset Mortgages
Offset mortgages can be repayment or interest-only like normal mortgages.
If you want a repayment mortgage, then you’ll need to decide between a payment reduction or term reduction offset. Most offset mortgage providers offer one or the other, but there are some who offer both.
If you want an interest-only mortgage, you’ll typically opt for a payment reduction offset as term reductions aren’t particularly effective for interest-only arrangements.
Please note: lenders may have different names for these options or offer variations, so you need to make sure you understand exactly which option you’re choosing – especially if your mortgage will have some or all of the balance on interest-only.
Payment Reduction
With payment reduction, your monthly interest payments depend on your net balance.
As we explained earlier, with an offset mortgage interest is charged on your net balance – i.e. the amount left over after the money in your linked savings account is deducted from the outstanding mortgage balance. This means that, if you have savings in your linked account, your interest payments and therefore your overall monthly payments will be less than they would be on a normal mortgage with no linked savings account.
Your mortgage term won’t be affected with a payment reduction offset.
Both repayment and interest-only offsets are available on a payment reduction basis.
Term Reduction
With term reduction mortgages, the interest owed is also calculated on the net balance – i.e. the amount left over after the money in your linked savings account is deducted from the outstanding mortgage balance.
The main difference between a term reduction and payment reduction offset is that with term reduction, you continue making the same monthly payments that you would make if you had no offset savings account and the interest was worked out on the total outstanding mortgage balance. This effectively means you make overpayments which can go towards your outstanding mortgage balance. You pay off your mortgage more quickly, thereby reducing the overall term.
What’s more, by reducing the term over which interest can be charged, you save yourself even more in interest payments over the full term of the mortgage.
Repayment offsets are available on a term reduction basis.
Example
Here are 2 examples of the most common offset arrangements. Please note these examples are generic, your own situation may be more complex. We suggest you talk to an adviser to see how an offset facility can best help you and your situation.
Interest-Only Mortgage with Payment Reduction
- You take out a 25 year, £250,000 interest-only mortgage with a 1.99% interest rate
- If this was a normal mortgage and you had no offset savings account, the lender would charge interest on the total outstanding mortgage balance
- Your monthly payments in this situation would be: £415
- If this was an interest-only offset with payment reduction and you had £50,000 in the linked savings account, the lender would charge interest on the net balance:
- The lender would charge interest on: £250,000 - £50,000 = £200,000
- Your monthly payments in this situation would be: £332
- This means you could save £83 per month for 25 years, which is a total of £24,900
Repayment Mortgage with Term Reduction
- You take out a 25 year, £250,000 repayment mortgage with a 1.99% interest rate
- If this was a normal mortgage and you had no offset savings account, the lender would charge interest on the total outstanding mortgage balance
- Your monthly payment in this situation would be: £1,058 for the full 25 years
- If this was a repayment offset with term reduction and you had £50,000 in the linked savings account, the lender would charge interest on the net balance:
- The lender would charge interest on: £250,000 - £50,000 = £200,000
- Your monthly payment in this situation would remain at £1,058, however the mortgage would be cleared in 22 years and 10 months
- This means your mortgage could be cleared 2 years and 2 months early and you could save £27,508
Find the Best Offset Mortgage Deals
Use our free best buys tool to compare the best offset mortgage rates on the market right now.
There are many different options available so we always recommend that you speak with a qualified adviser. We have access to the whole of the market which means we can make sure your mortgage caters to your unique situation.
Call us on 0330 433 2927to speak to an adviser today or send us an enquiry.
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