Offset mortgages have always been something of an enigma in the UK after being heralded on their first appearance as the future of mortgages. They have not taken off here in the same way that they have in Australia, for example.
Part of the reason initially lay behind the fact that advisers and lenders struggled to explain the concept to borrowers who then struggled to understand how they worked. But this was only part of the issue.
In reality, offsets are a relatively simple concept. A standard mortgage is taken out for, say, £300,000 and a savings account, or multiple accounts, are taken out with the same provider. The borrower then deposits their savings into this account which is then “linked” to the mortgage account. Every month the lender calculates the interest you need to pay based on the total amount borrowed on the mortgage less the amount held in the savings account.
In other words, if the borrower has a £300,000 loan, but also has £100,000 in the savings account, the interest is only calculated on the difference between the two, in this case £200,000.
This means that less interest is being paid and therefore either the monthly payments are reduced, or the capital balance is paid off quicker.
With savings interest rates being relatively poor at present, utilising spare capital to cut down your mortgage payments, or repay your mortgage more quickly, seems a much more beneficial use of money. After all, if you have a sizeable amount of cash on deposit struggling to earn 1 per cent in interest, offsetting against a mortgage you are paying 3 per cent on is a better use of that capital.
In other words, the “effective” return on that capital is much more than the standard savings interest rate. Also, as there is in effect no interest being physically received on the savings then there is no tax to pay on that interest. Hence this is of more interest to higher-rate taxpayers.
If used in the correct way, an offset mortgage really can make a tremendous difference. Not only is the sum held on deposit offset against the loan amount so the interest or the term of the mortgage is reduced, but also the amounts paid in remain liquid, (you can take out the savings whenever you wish, it is your money not the lenders), and are not limited in their protection to just the government guaranteed level.
Another interesting benefit is that parents can use their own savings to assist in bringing their children’s mortgage payments down, but still have access to their money.
In general, the clients who benefit most from this type of product are therefore those with access to a decent-sized savings pot, high net-worth individuals who may receive large bonus payments or those self-employed clients with variable income streams.
However, those who are willing to use their offset account as a current account can also experience some good interest savings. With most of these products now charging interest on a daily basis, savings are greater at the start of the month when their salary goes into the account, and then diminishes over the month, although savings are still made.