Should you get an offset mortgage?

You’ve probably heard of offset mortgages but if you’re not really sure what they are and how they work, don’t worry you aren’t alone.

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Only around 4% of borrowers have an offset mortgage according to figures from the Council of Mortgage Lenders, but speak to someone who’s got one, and they will probably tell you how great they are.

An offset mortgage won’t be the best option for everyone, but for many it could be something well worth considering. Here we look at how offsets work and who they suit.

What is an offset?

An offset mortgage enables you to link your savings, and often current account, to your mortgage. Everything has to be with the same bank or building society but they are kept in separate ‘pots’, so when you log into your offset account or receive a statement, you can see how much you have in savings, how much is in your current account and what your outstanding mortgage balance is.

Offsets are completely flexible in that you can access your money at any time. You don’t earn any interest on your savings but instead pay less on your mortgage.

For example, if you had a £100,000 mortgage and £30,000 in a linked savings account, rather than being charged interest on the full £100,000 loan, you’d only pay interest on £70,000.

However, your mortgage payments would be based on the full £100,000 - meaning you effectively overpay each month and therefore pay off your mortgage more quickly.

Someone with £30,000 in savings and a £100,000 repayment mortgage over a 25-year term, paying an interest rate of 3.49%, could shave five years off their mortgage term and save £11,648.51 in interest by offsetting.

In order to earn the equivalent amount of interest on their savings, a basic rate taxpayer would need an account paying 5.35%, while a 40% taxpayer would need to earn at least 5.90%.

This make offsets a particularly attractive option at the moment for those with large amounts in savings as there are no savings accounts paying those sorts of rates of interest. You can earn 5.00% if you are prepared to lock your money away for five years in a fixed rate bond, but the best you can get on an easy access account is 3.10%.

Who is an offset mortgage suitable for?

If you are a taxpayer and have savings, an offset is worth considering. You pay income tax on any interest earned in standard savings accounts - so basic rate taxpayers lose 20%, higher rate taxpayers 40% and those in the top tax band, 50%.

Therefore, for higher and 50% taxpayers in particular, offsetting your savings against your mortgage can be hugely beneficial: you save tax and pay less interest on your mortgage.

Offsetting can also be a great option for the self-employed as the money they set aside to cover their tax bill can be used to reduce the interest they pay on their mortgage in the interim. This often runs into tens of thousands of pounds - so it can make a significant difference.

Which lenders offer offsets?

The main offset mortgage providers are First Direct, Woolwich, Yorkshire Building Society and Scottish Widows, although some smaller building societies also offer them.

The other major player in this area is The One Account. Its mortgage is actually called a current account mortgage although it works in the same way as an offset, albeit rather than having separate pots for your mortgage, savings and current account they are all lumped in to a single account.

This means when you check your current account balance, you’ll appear to be thousands of pounds overdrawn because what you are seeing is your outstanding mortgage balance once your savings and current account balance have been deducted.

What are the best offset deals available?

As with standard mortgages there are fixed and tracker rate offsets depending on whether you want the security of knowing what your mortgage repayments will be each month or are happy to take a gamble and go for a variable rate deal.

First Direct has a two-year tracker at 2.29% (1.79 percentage points above the Bank of England base rate). However, in order to qualify you must have a deposit of at least 35% - and there is a fairly hefty arrangement fee of £1,499.

Alternatively, Yorkshire Building Society has a two-year tracker with a slightly higher rate of 2.39% but the fee is lower at £995 and you only need a 25% deposit to qualify.

It’s worth noting, though, that you can only link your savings to your mortgage with this deal as the building society doesn’t offer a current account.

If you’d prefer a longer term deal, Woolwich has a lifetime tracker at 3.29%. As with the Yorkshire two-year deal, it is available to those with a deposit of 25% or more. The fee on this product is £999.

For those wanting the security of a fixed rate, Yorkshire Building Society has the leading two-year options. You can either go for a rate of 3.09% and pay a £995 fee, or pay a slightly higher rate of 3.49% in return for a lower set-up fee of just £95.

Both products require a minimum deposit of 25%. If you are borrowing less than £175,000, the 3.49% option will actually work out cheaper over the fixed term.

Yorkshire is also offering the leading three and five-year fixed offsets. Both are available to those with deposits of at least 25% and carry £995 arrangement fees.

The rate on the three-year fix is 3.59%, while the cost of fixing your payments for five-year is 4.09%. It used to be the case that you’d have to pay quite a premium to offset, making them only worthwhile for those with significant savings.

But that’s no longer so and the rates on the offsets mentioned above stack up really well against the leading standard mortgages. You can find more information and view details of other mortgages on our mortgage channel.

Please note: Any rates or deals mentioned in this article were available at the time of writing.

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