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What are Offset Mortgages?
Having cash saved in a savings account might earn you some interest on your account balance but it might not generate much income, especially in times when interest rates are at historic lows.
Having an offset mortgage linked to your savings account might be a great way to save money on your mortgage interest.
We discuss further below how this works.
How do offset mortgages work?
Essentially how it works is by linking the savings in your bank account to your mortgage which will enable you to reduce the interest you pay on your mortgage loan. With a standard mortgage, you are charged interest payments based on the whole amount you owe.
Having an offset mortgage means the amount in your savings is deducted from the mortgage loan amount on which interest is charged. That means you’re not charged interest on the full balance of your mortgage loan. Bare in mind that this only reduces the amount interest is charged on but not the mortgage loan itself, which will still need to be repaid in full.
With mortgage rates normally being higher than a conventional savings rate, you could find yourself saving more on your mortgage interest rate payments than the interest you can make from a savings account.
The mortgage interest payment savings can be used to deduct the balance of your mortgage loan further. This can lead to lower monthly payments or you may find that you can pay off your mortgage quicker and by decreasing your mortgage term this could lead to further overall savings.
A benefit of an offset mortgages over making overpayments in a regular mortgage is that you can put the cash into your savings account to offset your loan balance further but you can access the money at any time (although you may be required to keep a minimum balance by some lenders) whereas making over-payments on a regular mortgage means the money is going to your lender and if you wish to raise capital, you would need to remortgage which could carry extra fees and certain criteria’s. Remember, withdrawing funds from your savings account would mean you’ll decrease the amount you save from your offset mortgage interest. That money will no longer be offset against your mortgage and repayments will increase.
Savings Account = £50,000
Mortgage = £200,000
£200,000 – £50,000 = £150,000
£150,000 is amount the mortgage lender would charge interest on, instead of the full £200,000.
If interest rates was 2%, by charging 2% of £150,000 (which is £3,000) in one year instead of 2% of £200,000 (which is £4000), you can make a saving of £1000.
With savings rate usually being lower than mortgage interest rates, an example of 1% savings rate on £50,000 would accrue £500 in one year.
This example shows the benefit of interest savings with an offset mortgage over the interest earned on your savings.
Advantages of an offset mortgage
• Instead of putting it in your deposit and having to remortgage when you need to raise cash, you can access the savings in your bank account when you need it.
• Can help reduce your mortgage term by putting the savings from interest payments towards deducting the original loan balance.
• Benefit of not having to pay tax on the interest earned from savings account.
• Can be a good arrangement for your finances if your savings account isn’t making much due to low interest rates.
Disadvantages of an offset mortgage
• Won’t earn any interest on the linked savings/ current accounts.
• Interest rates for offset mortgages can sometimes be higher and there may be a smaller pool of lenders to choose from, than a normal mortgage.
• If your savings are relatively low, it might be more beneficial to look for a conventional mortgage deal with the lowest rate.
• Possibility of needing a higher deposit, as offsetting can give a lower loan-to-value (LTV) ratio.
• May be charged a higher rate for overpayments with an offset mortgage.
Is an offset mortgage right for me?
For someone with a large sum in their savings account and don’t rely on the interest accrued for their living or is receiving low rates, an offset mortgage could help reduce their monthly payments and reap more lucrative benefits.
As profit made from interest earned from a savings account could be taxed after a certain threshold, but high earners and higher rate tax payers can find they save themselves from having to pay additional tax since there is no additional interest made from an offset mortgage, yet they are making savings on their mortgage payment.
Some providers will allow you to link several accounts to offset against your mortgage, including family members. This could be a way to help a family member get onto the property ladder.
Offset mortgages could be ideal for you if you are self-employed or a contractor to make the most of your money as you save for your tax bill. The cash built up in your account for tax could offset your mortgage interest.
Offset mortgages can seem complicated but you could potentially make some great savings. Offset mortgages may not work in the same way with every provider and each will have it’s own terms and conditions, features and benefits and choosing the right lender will depend on your required functionality and needs. Get in touch and we can discuss if an offset mortgage works out better for you.