Offset Mortgages:
Advantages, Disadvantages, and Key Considerations

Offset Mortgages

Offset mortgages can be a smart way to reduce the total interest you pay over the term of your loan by using your savings to "offset" part of the mortgage balance. In this guide, we'll explain how these mortgages work, the pros and cons, and why speaking to a whole-of-market broker can help you find the best deal.

What is an Offset Mortgage?

An offset mortgage allows you to use your savings to reduce the amount of interest charged on your loan. Instead of earning interest on your savings, the savings are offset against your mortgage balance, lowering the interest you pay. For example:

• Mortgage: £100,000

• Savings: £10,000

• Interest charged on: £90,000

You’ll pay interest only on £90,000, not £100,000, effectively reducing your overall costs. While your savings won't earn interest, this trade-off is often beneficial, as mortgage interest rates are typically higher than savings rates.

Who Qualifies for an Offset Mortgage?

Anyone with savings could qualify for an offset mortgage, though it's most beneficial for:

• Individuals with large cash reserves

• Self-employed workers with fluctuating income

• Higher-rate taxpayers, as offset returns are classed as "avoiding interest," exempting them from tax on linked savings

Contractors especially benefit, as they avoid paying 20% or 40% income tax on their savings.

Advantages of Offset Mortgages

Offset mortgages provide several benefits:

• Interest savings: You can reduce the interest you pay over the mortgage term, potentially shortening the loan term or lowering monthly payments.

• Tax advantages: You avoid paying tax on your savings since the return comes from reducing interest on your mortgage.

• Access to savings: You can still access your savings at any time without needing to remortgage.

• Family offset options: Parents can use their savings to help their children onto the property ladder without contributing a deposit.

• Buy-to-let offset: Landlords can use an offset mortgage to reduce monthly payments and maximise rental income.

Disadvantages of Offset Mortgages

Despite the benefits, there are some disadvantages:

• Higher rates: Offset mortgages typically have higher interest rates than standard mortgages.

• Limited lenders: Fewer providers offer offset products, making it harder to find deals.

• Larger deposits: Most lenders require at least a 20%-25% deposit for an offset mortgage.

• Savings accessibility: Withdrawing savings will reduce the benefits, as it increases the mortgage balance against which interest is charged.

Eligibility Criteria

To qualify for an offset mortgage, you’ll need to meet standard mortgage requirements, including:

• Savings account: Your savings must be held in an account with the mortgage provider.

• Deposit: A minimum deposit of 25% is typical, though some lenders may offer lower deposit deals for existing customers.

• Income/affordability: Lenders use a multiple of your income, generally around 4.5 times, to determine borrowing limits.

• Employment type: Self-employed applicants may need to provide proof of income and may benefit from contractor-specific offset products.

• Credit history: Good credit is generally required, though specialist bad credit lenders are available.

Offset Mortgages vs. Overpaying

If you make full monthly payments on an offset mortgage, you are essentially overpaying and reducing the loan faster. This has the same benefit as overpaying on a traditional mortgage, but with an offset mortgage, you retain access to your savings if needed, without needing to remortgage.

Offset Mortgages vs. Savings Accounts

For those paying high mortgage rates but earning minimal interest on savings, an offset mortgage can be a better option. You won’t earn interest on the savings, but the money saved in reduced mortgage interest often outweighs the lost interest income.

Types of Accounts That Can Be Used

Several types of savings accounts can be linked to offset mortgages, depending on the lender:

• Cash ISAs: Some lenders allow cash ISAs to be linked, though fixed-term ISAs and stocks and shares ISAs are generally excluded.

• Current accounts (CAMs): These function similarly to offset mortgages but combine the current account and mortgage into one.

• Business accounts: Sole traders may be able to use their business accounts if held with the lender.