With any mortgage type, you will be paying capital (the balance) and the interest (at a percentage of the remaining balance). If you would like to reduce the amount of interest you pay per month, you may benefit from an offset mortgage.
When a customer takes out an offset mortgage, they will have a savings account opened by their mortgage lender, that will run for the length of the mortgage term. This savings account doesn’t pay back your mortgage balance, but instead lowers the amount of interest you’ll pay.
So let’s say, for example, you had a £100,000 mortgage to pay off and put £20,000 into your savings account. You will still have a £100,000 mortgage to pay per month, but you would only be paying interest on £80,000.
The amount of interest you pay will typically be calculated at a percentage of your mortgage balance, which is what brings the overall cost up. This means that the more interest you offset into your savings account, the less you’ll be paying back overall, saving you money.
As touched upon, the money that goes into your savings account will offset against the interest, reducing the amount you pay overall. Unlike a typical savings account, you will not pay tax on your savings. This is especially beneficial for higher rate taxpayers.
A potential downside to this type of mortgage, is that your savings will not grow either. You will not earn any interest on the savings that are tied to your offset mortgage.
Even still, this may not be enough to deter a potential applicant, especially with the money you could save by offsetting the interest. Another positive to it, is the flexibility of the account.
Using the previous example of a £100,000 mortgage and £20,000 in savings, if you then needed to dip into your savings as an emergency fund for something, you are free to do so. It’s important to remember though, that you would pay interest on a higher amount again.
So whilst you would only be paying interest on £80,000, if you drew out £10,000, you would be paying interest on £90,000 again until you deposited more back into your savings account.
You will still be responsible for keeping up your monthly mortgage repayments, you would just be paying less on interest.
If you were able to offset the entire balance towards the end of your term (perhaps a combination of work bonuses and inheritance helping you reach this goal), you would still be responsible for the repayment side of things, until your term ends and the balance is paid off.
As mentioned previously, monthly mortgage payments are a combination of interest and capital. Whilst offsetting the entire balance would effectively reduce your interest rate to zero, the capital doesn’t go anywhere and needs to be paid.
Depending on the mortgage lender you are with, you may have the option of repaying your mortgage by a specific additional amount each year. Generally speaking, it’s up to 10% per year, though you should always ask your mortgage lender first.
Overpaying by too much per year can lead to you potentially owing an early repayment charge.
Whilst you may be limited on the amount you can overpay on the mortgage balance, you are free to deposit as much as you’d like to into your savings, whenever you would like to do so.
There are a lot of factors to consider with an offset mortgage, as to whether or not it is the right option for you. This can be quite difficult to decide on, especially if you are applying for a first time buyer mortgage.
At the end of the day it’s all about weighing up the pros and cons. As said above, higher rate taxpayers will see the benefits because they can deposit savings tax-free. There’s also the flexibility of these mortgage types, with the freedom to deposit and withdraw as you see fit.
Another positive, especially for first time buyer mortgage applicants, is that someone else may be able to offset against your mortgage. This means a family member could lower your interest rates, helping you to own your own home, though it would depend on the mortgage lender.
On the other side of the coin, you have the fact that offset mortgages are typically at higher interest rates than other mortgage deals that could be out there for you. You are essentially paying a premium for a flexible mortgage type with the ability to offset.
Additionally, as mentioned, you won’t earn interest on those savings as you would with a standard savings account. Furthermore, whilst coming into more money could allow you to offset your interest rates, you could also choose to overpay your mortgage instead.
There are plenty of reasons as to why it’s both a good and not so good idea for a home buyer. At the very least, you need to be paying a significant amount into the savings account for it to be worthwhile, especially with the potentially higher initial costs included.
By booking a free mortgage appointment and speaking with a trusted mortgage broker, you’ll benefit from mortgage advice regarding offset mortgages and how they could potentially aid or hinder you during your mortgage journey.
Get in touch with one of our mortgage advisors and we will see how we are able to help.