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.

Adding to an Offset Mortgage

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.

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Benefits of an Offset Mortgage

Offset mortgages suit many borrowers, in particular those with variable incomes, including the self-employed and those who earn bonuses or large amounts of commission. They can also work favourably for borrowers with cash savings in a bank or building society account.

Many self-employed people use offset mortgages as a method of saving in order to pay their annual tax bills. During the year, the money put aside for HM Revenue & Customs contributes to reducing the mortgage debt, until the payment date is reached when the tax bill is paid.

However, you do not have to be self-employed to benefit from an offset mortgage. Anybody who likes the idea of whittling away their mortgage over time and reducing the overall term (and total amount of interest paid) should give consideration to an offset mortgage.

Family Offset Mortgages

Some mortgage providers (e.g. Yorkshire Building Society, Newcastle Building Society) offer family offset mortgages, where parents, for example, can offset some (or all) of their savings against a child’s mortgage debt. Family offset mortgages also offer scope to reduce potential tax liabilities.

Offset Mortgages v Current Account Mortgages

Savings and debts are held in separate accounts for an offset mortgage, whereas for a current account mortgage (CAM) everything is held in a single account. For many borrowers, there is little to choose between the two options, other than the bad impression that a CAM might give of seeing the size of your ‘overdraft’ every time cash is withdrawn from a ‘hole in the wall’.

A CAM will only give one balance for all of the linked accounts. This can lead to difficulties in keeping track of the exact balances of all aspects of the current account mortgage. The danger is that the borrower becomes complacent about the substantial negative balance on the account and sees no difficulty in adding a further few hundred pounds to the overdraft to finance a purchase that cannot be afforded based purely on the income of the borrower.

However, it should be noted that with an offset mortgage, if a borrower has savings in a Cash ISA (Individual Savings Accounts), the savings can be offset against the mortgage without having to close the ISA and the ISA would still be retained after the mortgage has been paid off. This would not be possible with a CAM.

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Offset Mortgage Variations

Offset mortgages follow a similar pattern to other types of mortgages, with links to one or more savings accounts or current accounts. Most mortgage providers offer a choice of three different offset mortgage types:

When offset mortgages were introduced to the UK mortgage market, interest rates were pitched at around 1 percent higher than for corresponding conventional mortgages. With increasing competition in this sector, the interest rate gap has narrowed, in recent times.

If you can be bothered to arrange a remortgage every 2 to 3 years, you could possibly continue to find an alternative mortgage at a lower rate of interest than an offset deal. However, over longer periods, offset mortgages are extremely competitive and offer the flexibility for borrowers to make underpayments or overpayments depending on their financial circumstances.

Statistics produced by the Royal Bank of Scotland indicate that an increasing number of borrowers are choosing to repay their mortgages early, so offset mortgages (which facilitate this practice) are likely to continue to increase in popularity.

Offset Mortgages - Brokers

Some mortgage brokers are ambivalent about offset mortgages.

Because borrowers who choose offset mortgages will probably remortgage less frequently than conventional mortgage holders, some mortgage brokers have chosen not to promote offset mortgages to any great extent. To counteract this tendency, other offset mortgage providers have increased the procuration fees that they offer to brokers for marketing this type of product.

Ironically, availability of these higher procuration fees has led to accusations that a number of mortgage brokers have been selling offset mortgages to clients who would be better off with alternative mortgage products, simply to earn the higher fees associated with offset mortgages.

Nevertheless, a reputable mortgage broker should give independent and unbiased advice regarding offset mortgage options.

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Practical Effect of an Offset Mortgage

In order to see just how or if you would benefit from an offset mortgage, it may be helpful to look at a practical example of how an offset mortgage works.

Consider a £100,000 mortgage that has a 20 year term at an interest rate of 5.75 percent. This mortgage on a standard repayment option would cost £479.17 a month, resulting in a total amount that would be paid back by the end of the 20 years of £215,199.

Now consider that the borrower has a savings pot of around £50,000. If this is used against the mortgage, the duration of the mortgage would drop by approximately 2 years, resulting in the total cost of the mortgage being £204,451 a saving of £10,748.

Alternatively, if the borrower continued to pay the mortgage over 20 years, they would then benefit from a lower monthly payment of £455.21, a monthly saving of £23.96. Overall, this means that the cost of the mortgage is reduced to £209,449 a saving of £5,750, whilst still allowing the borrower access to their savings as required.

Bear in mind that these calculations do not take into account the tax saving that the borrower would gain. If they maintained £50,000 in an interest paying savings account, then tax would be payable on the income at the income tax rate that the borrower is paying on other income, which could be as high as 40 percent. In almost all cases, the interest rate that a borrower pays in relation to the mortgage borrowing is likely to be higher than any interest rate that would be received from a savings account, particularly when the tax liability is taken into account.

Offset Mortgage Providers

Many high street lenders now offer an offset account of some description. Offset account lenders normally require that the entire income of the borrower is paid into the account. Offset mortgages provide lenders with an opportunity to cross sell other products, thus gaining a loyal customer for the future, not just for the duration of the mortgage.

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