It might be an unfamiliar term, but don’t let that put you off.
Why? Well, if you understand exactly how an offset mortgage works and think it will suit your circumstances, it could save you hundreds, if not thousands, of pounds in interest.
What is an offset mortgage?
Put simply, an offset mortgage allows you to use any credit balances in your savings or current accounts to reduce your mortgage balance.
Let’s say you have a mortgage of £150,000 and £10,000 in a linked savings account. The credit balance would be offset against your mortgage so you would pay interest only on the difference of £140,000.
You can then either keep your monthly payments the same and pay off the mortgage early, or you can choose to lower your monthly payments according to the credit balance in your linked accounts.
What else do you need to know?
You don’t need a lot of money in savings to make a difference to your mortgage. For example, a credit balance of £2,500 could knock seven months off the 25-year term of a £100,000 home loan.
The money in your savings accounts is not used to pay off the mortgage. It just sits in the accounts doing its offsetting thing, which means you can access the funds at any time.
The linked accounts must be with the same bank or building society as the mortgage. They also usually have to be in the same names as the mortgage, or the same name as one of the mortgage holders if you have a joint home loan.
Some offset mortgages allow you to overpay each month for even bigger savings. However, if you overpay your mortgage, you cannot always draw down the overpayments if and when you need the money.
Is offsetting right for you?
Offset mortgages work well for people with variable incomes, or who earn bonuses or commission. They can also be useful if you are putting money aside, perhaps for a tax bill or a big purchase, and would like the money to work hard in the meantime.
An offset deal is particularly attractive when savings rates are low. You don’t earn interest on the money in your linked savings accounts but you are effectively earning interest at the mortgage rate instead.
Plus, you pay no tax on the interest you save, which can boost the appeal of offset mortgages, especially to higher rate taxpayers.
Let’s say you have a £100,000 mortgage at an interest rate of 3%. You also have £10,000 in linked savings, so you pay interest on a mortgage of just £90,000. You could therefore save interest of £300 over one year.
If you instead leave the £10,000 in a savings account paying interest of 2% - a generous rate right now – you would earn £160 as a basic-rate taxpayer and £120 after higher-rate tax. In other words, you save more interest than you could earn. You would also have to pay the extra £300 on your mortgage.
Are there any downsides?
Remember that you don’t earn interest on your savings, so an offset mortgage is not a good idea if you live off savings income.
It’s also worth bearing in mind that your savings won’t grow, so they will lose their spending power over time.
Finally, interest rates on offset mortgages can be higher than for standard loans, which makes it all the more important to shop around for a good deal.
Please note: any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.