Offset mortgages

All the credit balances in your savings and current account are offset against your debit balances, with interest being charged on the net amount of debt only. So if you have £10,000 of savings and a mortgage of £100,000 you would be charged interest on the net amount: £90,000. Because the credit interest is offset against the mortgage, rather than actually being paid, you effectively earn tax free interest on your credit balances at the same interest rate as is charged on the mortgage. This is particularly advantageous for higher rate taxpayers.

The available facilities of offset mortgages vary and not all of them will offer, say, a current account as part of the package.

The majority of new mortgages of this type take the form of an offset mortgage, rather than a current account mortgage, but effectively they perform in the same overall way.

What type of interest rate?

As with traditional mortgages, offset mortgages are available as a fixed rate mortgage, a tracker mortgage or as a discounted rate mortgage.

It is important to note that, because the balances in the savings account and current account are offset against the mortgage, you do not actually physically get paid interest on them. That is also why there is no income tax payable on the savings’ interest.

The interest rate applicable at the end of any initial introductory period (known as the ‘revert to’ or ‘go to’ rate), is for many offset mortgages a tracker linked to a margin over the Bank of England base rate, which may compare favourably with the standard variable rate of conventional mortgages.

Be aware that interest rates charged on offset mortgages tend to be slightly higher than for standard mortgages. However, this differential has narrowed considerably in recent years and some lenders no longer charge a premium for offsets.

Advantages of offset mortgages

An advantage of offsets is that if you are committed to offsetting over the long term, you won’t face the hassle or expense of having to remortgage every few years. Note that it is possible to remortgage away from an offset should you so desire, but as with all mortgages, make sure that you are aware of the amount of any early repayment charge (ERC) and the period for which it applies.

Offset mortgages come with flexible features, such as permitting overpayments, underpayments or payment holidays (but remember that some non-offset mortgages also carry these features). However, you need to be disciplined to take advantage of such features as the apparent availability of a very large overdraft may prove to be a temptation too far for some.

Offset mortgages also allow you to make large lump sum payments to reduce the size of your mortgage; making them attractive to individuals in receipt of large bonuses, commissions or who have a fluctuating income.

By offsetting your savings – and maybe current account – against your mortgage, you will pay less mortgage interest, less tax and if you make overpayments from time to time, you will clear your mortgage more quickly.

Who are offset mortgages suitable for?

As a generalisation offset and current account mortgages may suit borrowers with one or more of the following characteristics:

• Higher rate taxpayers
• People with a reasonably high level of savings
• Individuals with irregular income streams (eg the self employed or those for whom a large part of their income is received in the form of an annual bonus)
• Those with buy-to-let properties
• Those who have to pay school fees.