Offset mortgages are a variation on current account mortgages. Originally devised in Australia, offset mortgages were introduced to the British market in the late 1990s.
The principle of offset mortgages is relatively simple but the implementation can be more complex. When a borrower takes out an offset mortgage, it is linked to their savings account or current account, allowing them to offset their mortgage debt against cash that they already have in savings, which reduces the amount of interest owed. For example, if a borrower has a £200,000 mortgage and £30,000 in savings, they will only pay interest on the difference (i.e. £170,000), thus offering the option of reducing the mortgage term by several years.
Because savings interest rates are currently so low, the loss of interest on savings is almost certainly more than outweighed by the reduction in mortgage interest instead. For higher rate income tax payers, the differential is even wider because their savings interest would be taxed at 40 percent, whereas the reduction in mortgage interest does not attract any tax liability; offsetting savings against a 6 percent mortgage is calculated to be equivalent to earning 10 percent in a savings account.
With many offset mortgages, other debts such as personal loans and credit card debts can also be linked, allowing them to be paid off at the much lower mortgage rate of interest.
Even though they are being repaid at the lower rate, these loans remain unsecured, so the borrower does not risk losing their home if they default. The downside, however, is that the borrower could risk turning what was a short-term debt into a long-term debt. Because interest owed is calculated on a daily basis, the borrower could end up paying far more interest than they would have done had they bitten the bullet and paid off the original debt on schedule.
When using an offset mortgage, the most important factors are: (i) to remember, at all times, to remain in control of the accounts, and (ii) to keep track of how much is being paid in relation to each amount owing.
With an offset mortgage, the current account remains separate in terms of seeing the balances of the mortgage and any other related account such as loans or savings accounts. This can make it a lot easier to keep track of whether or not the mortgage is under control and that the overall interest levels you are paying are still favourable in comparison to a standard mortgage.