Get money saving tips in our regular emails

We take your privacy very seriously

Offset Mortgages – What Are They and How Do They Work?

Offset mortgages

in Mortgages

The concept of offset mortgages is relatively new to many people; having entered the UK markets just a couple of decades ago. The scheme can be best explained as just another mortgage option where the mortgage amount is offset by the borrower’s credit balances in terms of savings or current bank accounts. This offset results in a reduced mortgage interest rate as the interest is now calculated and charged on the net balance. The borrower stands to gain at least a couple of month’s interest in the process, depending on the actual credits adjusted. The scheme, however, is not by default suited to all borrowers and requires constant monitoring to derive maximum benefits for the parties involved.

The Workings

With the basic definition in mind, let us proceed to take a look at how offset mortgages work in real time.

The mortgage debt when adjusted against a credit balance not only brings down the overall debt but also cuts down the interest on the mortgage value (which in essence is the net balance). For example, a £100,000 mortgage when offset by a savings account balance of say, £25,000, effectively becomes a £75,000 loan, incurring interest only on the net value of £75,000. Mortgage interest is calculated on a daily basis and favours the borrower as the liabilities are adjusted regularly on a consistent basis.

Linked accounts, however, should be constantly monitored as well. The credits can be sourced from multiple accounts if the need arises. It is important to note that the savings once adjusted against the debt will no longer earn any interest as the borrower is required to transfer the account to the lender bank. Although the savings will be available to the borrower for other emergency expenses, the cash will not earn any interest for the borrower.

On the other hand, the borrower will be able to save on the taxes that are otherwise payable on the 4 per cent interest usually earned by the savings account balance. In fact, the savings will roughly earn about the same rate of interest charged for the mortgage, which would be totally tax-free.

An offset mortgage rate is comparatively higher (up to 1 per cent) than conventional mortgage schemes, though the difference is fast fading due to stiff competition in the market.

Advantages

Offset mortgages offer several benefits in addition to bringing down the liability and interest rates. Tax saving is of course the top benefit of the scheme, especially for those who incur high tax rates of 40 per cent or more. Despite higher interest rates, these mortgages may prove cheaper in the long run.

The scheme is quite flexible when compared to other mortgage options available in the market. The borrower will be able to overpay or underpay the installments depending on the availability of credit. Borrowers can either choose to overpay their debts within the stipulated term, save on high interests and get rid of debts faster, or stick to the original term while managing funds to meet other expenses. Contract employees and self-employed professionals can accordingly manage their repayment options depending on the bulk payments at the end of their contract assignments.

A sudden inflow of cash can be adjusted against the loan, the term can be interspersed with payment holidays during lean times, and additional credits can also be partially or completely withdrawn when required.

Daily interest calculation offers better repayment rates when compared to interest calculated for the total payable mortgage.

Applicability

Offset mortgages are ideally suitable for:

  • Those with decent credit balances (of at least 20-25 per cent of the mortgage value)
  • Those who incur high tax rates of 40 per cent or over
  • Self-employed individuals with regular cash savings towards bulk tax or premium payments
  • Contract workers with irregular earning patterns, commissions or bonuses

Those who opt for offset mortgaging should be financially organised individuals who can carefully track accounts and manage financial affairs in order to make the most of this scheme. Although the scheme may sound simple and fairly straightforward to many individuals, it is very important that the borrower asks for a personalised offer before he evaluates and commits to the terms and conditions.