6 min read

Offset mortgages explained

Andre Spiteri
15 May 2017

What is an offset mortgage? And why would you choose it over another type of mortgage?

While offset mortgages can save you money and help you clear your mortgage sooner, they’re not necessarily right for everyone. In this article, we’ll give you a rundown of how they work and discuss their pros and cons.

What is an offset mortgage?

An offset mortgage is a mortgage that’s connected to another bank account - typically a savings account. The balance in the account helps towards your mortgage. Offset mortgages work the same way as any other mortgage, except that interest is calculated differently.

Interest on a conventional mortgage is calculated on the total amount borrowed, minus any repayments. By contrast, interest on an offset mortgage is calculated on the outstanding amount, less the balance in the connected account. In other words, the money in your account reduces - or offsets - your mortgage’s outstanding balance. This usually means you pay less interest.

An example of how an offset mortgage works
Let’s say you need to repay £250,000 on your mortgage at 3% interest.

If you’ve taken out a traditional mortgage, interest would be calculated on the full amount outstanding, i.e. £250,000.

Now, let’s say you have an offset mortgage, and £50,000 in your connected account.

In this case, you would only pay interest on £200,000, and not on the full amount.

Why go for an offset mortgage?

The biggest advantage of an offset mortgage is the potential for large savings. Since your mortgage interest is calculated on a lower amount of borrowing, you could pay much less on an offset mortgage than you would on a conventional one. This gives you the chance to either decrease your monthly repayments or continue to ‘overpay’ and repay your mortgage more quickly.

The money in your connected account stays yours

The money in your connected account is only subtracted from your mortgage in order to calculate the interest due. It’s never used to make repayments. You can keep using your account as usual and make as many withdrawals as you like at any time throughout the duration of the mortgage.

This makes an offset mortgage a good choice if you have a large pot of savings but you’re not comfortable tying it up by using it to pay for your property. It allows you to save on interest, but still gives you the flexibility to access your savings should you need them.

An offset mortgage also allows you to use your savings tax-efficiently. The account connected to your mortgage doesn’t accrue interest, so no tax is due. At the same time, no tax is due on what you save by offsetting your savings against your mortgage, either.

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Offset mortgages: the disadvantages

1 - The current or savings account you connect to your mortgage usually won’t be able to earn interest.

However, this could end up being an advantage. If your account attracts a low interest rate, the amount you could save on your mortgage could be larger than any amount you could stand to earn in interest.

2 - Interest rates on offset mortgages are generally higher than the rates on conventional mortgages. For this reason, an offset mortgage is only worthwhile if you have a bank account with a large enough balance.

If your balance is low, you might end up paying more in interest than you would on a conventional mortgage. Make sure you do the maths before you make your final decision.

3 - While you’re free to use the money in your connected account as you please, making large withdrawals isn’t advisable. To get the most out of an offset mortgage, you should leave your balance unchanged as much as possible. If you can’t afford to park your savings long-term, a conventional mortgage with a low interest rate might be a better option.

Family offset mortgages
Some offset mortgage providers allow you to link your mortgage to a relative’s account. This is great if you don’t have money set aside, but your parents or grandparents do and they’re willing to help you out. As with other offset mortgages, they retain full control over the money in the account. However, making large withdrawals will defeat the purpose.

In a nutshell:
  • An offset mortgage is connected to another bank account. Any money in that account offsets your mortgage’s outstanding balance. This usually results in less interest.

  • An offset mortgage can work out cheaper and be repaid more quickly than a conventional mortgage.

  • Interest rates are typically higher than those of conventional mortgages. Unless you have a large sum of money saved up, an offset mortgage might not be worthwhile.

by Andre Spiteri

Andre is a former lawyer turned financial writer. Andre has written this article especially for ClearScore.

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