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.

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:

• Fixed rate;
• discounted rate;
• standard variable rate (SVR).

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.

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.