What is an offset mortgage?

This article is part of
Guide to offset mortgages

What is an offset mortgage?

An offset mortgage combines the traditionally separate mortgage and savings accounts. 

Some of the forerunners to offset mortgages bundled mortgage and savings balances together in one big account.  

That resulted in the borrower effectively having one big overdraft that would rise and fall as salary and savings were paid in and withdrawn.

Offset has since been dominated with borrowers clearly preferring the separation of the two accounts enabling the customer to clearly see what they owe on the mortgage and have accumulated in the savings pot.

Bernard Clarke, communications manager of the Council of Mortgage Lenders, says these days an offset mortgage is a good but simpler idea offering those with some savings the option to offset them against the mortgage balance.

These days rather than pay any interest on the savings balance it reduces the interest charge on the mortgage balance. 

So, for example, a client borrows £120,000 and has £20,000 in a current account and savings accounts linked to the mortgage.  

Mortgage interest is charged on £100,000 instead of the £120,000.

In many cases the borrower can elect to reduce their payment or to maintain their payment at the same level.  

Gathering momentum

By taking the latter approach, the borrower overpays slightly each month and therefore erodes the capital balance more quickly.  

David Hollingworth, associate director of communications at L&C Mortgages, says that can really gather momentum, potentially saving thousands in interest over the life of the mortgage and even paying it off altogether several years early.

By reducing the mortgage interest the savings effectively earn the mortgage rate.  

Mr Hollingworth says that is likely to be a better return than cash, especially as there is no tax to pay as no interest is earned.  

Mr Hollingworth says: “The personal savings allowance has levelled the comparison to a degree but a higher rate tax payer would need to earn a gross savings rate of 5 per cent to achieve the same effective return as offsetting a mortgage at a rate of 3 per cent.”

On the downside mortgage rates on an offset deal are likely to be a touch higher than a traditional mortgage, Mr Hollingworth warns.

As a result, Mr Hollingworth says the borrower needs to be sure that they will use the functionality adequately and have a large enough savings balance to more than make up the difference in rate.

Putting money to work

Ultimately though offset means that a client could reduce their outstanding loan quicker than a standard mortgage, says Christine Newell, mortgages technical director at Paradigm Mortgage Services.