Offset mortgages

There is confusion over whether offset mortgages are a product that can cater to everyone, or whether they are best suited to wealthier individuals with sizeable savings.

Offset mortgages were launched in the UK in 1994 but were slow to take off, because, some say, of the public’s lack of comprehension about how they work. At the time, rates on these mortgages also tended to be less competitive than on mainstream mortgages. But, in the past few years they have gained status, with some providers claiming they can slice years off mortgage repayment years.

Because rates vary according to the amount held in savings or current accounts, it can be difficult to compare deals, but experts say they have become better value in recent years.

How do offset mortgages work?

They offer a more flexible way of repaying your home loan than conventional mortgages as they link your credit (money held in a savings or current account) with your debt (your mortgage). The amount of interest that you pay out on your mortgage is then calculated by deducting the amount in your current or savings account from your total loan. This means that if the amount you hold in credit goes up, the amount of interest you pay on your mortgage goes down.

You can reduce the interest you are paying on your mortgage by putting lump sums such as bonuses into your savings or current account at any time. Normally there are no penalties for early mortgage repayment.

If you take out an offset mortgage and have savings you are effectively earning gross interest on these. If your savings were in a savings account not tied to your mortgage, you would pay tax on this interest.

For example, if you purchase a house with a 25-year mortgage of £250,000 and had £25,000 in savings, you pay mortgage interest on only £225,000. Based on this example, Intelligent Finance calculates that taking out a plan such as its Offset Tracker 85, which sets interest rates at 0.05 percentage points above the Bank of England base rate, will result in total savings in interest of £61,588.26 over the entire mortgage term.

What are the different types of offset accounts?

You can choose whether you offset using just your savings account or your current account as well.

Using your current account balance to offset against your mortgage will not make much of a difference if this account only averages a small positive balance. If it is regularly in credit with many thousands of pounds you might just as easily shift this money to a savings account.

However, using the above example of a £250,000 mortgage, if the borrower also linked in his current account he could still save money even if he had spent most of his bank account balance by the end of each month. If £3,000 is paid in at the start of the month, even with only £100 left at the end, it could save more than £82,0000 in interest over the lifetime of the mortgage.

Family offset mortgages are also available, where other family members offset their savings against another individual’s debt. The family members effectively save tax on their savings income and maintain complete control over their savings and can withdraw their money at any time. Newcastle Building Society and Yorkshire Building Society offer family offset mortgages, but Woolwich recently pulled out of the market after failing to attract enough customers.

How do they compare with conventional mortgages?

Antony Williams, financial planner at Evolve fp, says if you compare the headline rate of an offset mortgage with a conventional mortgage it does not look competitive. However, if you don’t want to change your mortgage every two years to chase the best deals, then an offset rate is generally more competitive.

“If you look at interest savings, these do depend on your tax rate and how much cash you have going in but overall I think they are good value,” he says. Williams says Intelligent Finance and Woolwich are leaders in the field. “Their offset mortgages include current accounts too, and the fees they charge are competitive.”

Who else offers these mortgages?

All the major lenders offer offset mortgages in some form. The fees are not generally high and they differ mainly in the range of product they provide. Some, such as Virgin, have changed the presentation of offset mortgages now so that borrowers can distinguish between their credit and debt because research showed that borrowers responded negatively to seeing a large debt each time they went to the cash machine.

What are the dangers of offset mortgages?

One of the main criticisms levelled at offset mortgages is that some offer loans larger than the original mortgage, so it is theoretically possible to increase debt during the mortgage period.

They also do not protect you against interest rate rises. And they require discipline. Unless you have money in your current or savings account, you do not benefit from offsetting and will be paying higher interest rates on the whole of your mortgage loan than you could get from a competitive deal on a conventional mortgage.

Who are they most suitable for?

People with significant savings will get the most out of this product as will higher rate taxpayers. For those who are taxed at 40 per cent on the interest on their savings, it makes sense to reduce the interest on the mortgage rather than generate it on savings.