Offsetting your mortgage

One of the cleverest developments in the mortgage industry over recent years is the idea of an Offset mortgage, whose fairly novel concept was designed to take into account someone's entire financial situation and use it to save them money on their mortgage.

Whilst this sounds fine so far, this type of arrangement is more complicated than a conventional mortgage and, as a result, tends to not be well understood. However, with more and more lenders offering these types of mortgage, it is important to be clear of the facts before deciding if an Offset mortgage is right for you.

How do offset mortgages work?

The idea behind the offset mortgage is that any savings you may have are counted (or offset) against the value of your mortgage and you then only pay interest on the balance. In other words, the lender will charge you less interest on your mortgage depending on the amount of savings you have built up.

For example: Let's say you owe £100,000 on your mortgage and you have £20,000 in a savings account. In this scenario, the lender would calculate the difference of these two amounts and charge you interest on the balance, which in this example is £80,000.

The offset calculation is usually done on a daily basis meaning that any money in the account, even if it is only there for a short time, would benefit you. A good way to take advantage of this would be to have your wages paid in at the beginning of the month and then all your bills come out at the end of the month, which would again increase the savings you could make.

Usually, this type of mortgage would require you to have a separate account or accounts with that lender and it would need to be electronically connected to the mortgage. This then allows the lender to easily make the necessary calculations and it could potentially save a great deal of money simply by not having to pay as much interest.

Of course, you would still need to make a monthly payment for your mortgage but the result could be that you repay your mortgage much earlier than the original term and can even be a very tax efficient way of making your savings work harder.

So what's the catch?

Whilst this may all sound great, it is not for everyone and it is advisable to get professional mortgage advice to work out if an offset arrangement would work for you.

One of the most important factors to consider is the underlying interest rate on these types of mortgages which is often higher than conventional mortgages. This means that if you do not have any savings to offset or were likely to quickly use any savings that you have, for example when buying a house, then there may be more suitable mortgages available.

Another important thing to remember is that whilst your savings are being offset against the mortgage, they will not earn any growth interest and you will need to consider whether the potential savings justify this. However, this does offer some advantages for tax payers as your savings would no longer attract interest on which tax is payable.

For example: Without offsetting, let us assume your £20,000 savings are earning 5% interest but on that, you are being taxed at 20% (for non-higher rate tax payers). This means that your savings actually earn you 4% per annum. By offsetting, you would effectively save interest at the mortgage rate which, as long as this is above 4% per year, would work in your favour and nothing would go to the tax man.

These types of mortgage require you to have a linked account with that lender in which to put your savings. Some people may prefer to keep their savings spread out rather than all together so this may not appeal for that reason. Also, to really take advantage of the potential savings, most lenders will suggest changing current accounts which again may not be for everyone.

The final point to be aware of is if you were to get into a situation where you have more money in savings than on your mortgage. This would effectively mean that you were not being charged any interest at all on your mortgage but equally the excess amount would not be earning interest. This can be simply rectified by moving excess funds back into an interest bearing account but this would need to be managed regularly.

Overall, the offset mortgage is a great concept and can work very well for some people but it is important to consider your whole financial situation and weigh up the advantages and disadvantages before committing to this type of financial arrangement.

Your home may be repossessed if you do not keep up repayments on your mortgage.