Mortgage Guides

Offset mortgages

By Hazel Cottrell hazel@consumerchoices.co.uk

What are offset mortgages, how do they work and how can they save you money? (Updated 29/9/09)

Interest rates on savings accounts at a depressingly low level, and more and more people are looking for new ways to make their savings work for them.

One way of utilising your savings is in an offset mortgage. In this guide we look at how offset mortgages work and explore the pros and cons of getting one.

• What is an offset mortgage?
• What are the advantages of offset mortgages?
• What are the disadvantages of offset mortgages?
• Types of offset mortgages
• Are my savings safe?
• Recommendation

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What is an offset mortgage?

An offset mortgage (or a mortgage with an “offset facility”) allows you to use your savings and/or your current account deposits to reduce the amount of interest you pay on your mortgage. It takes advantage of the principle that we tend to get less interest on our savings and current account balances than we pay on our debts.

By keeping your savings linked with your mortgage, you can “offset” a proportion of the loan, on which you will then not have to pay interest. For example, if you have a mortgage of £100,000 and use your savings of £10,000 to offset it, you will only be charged interest on the “net” balance of £90,000.

Let’s take an example of a flexible offset mortgage at 4.3%. In effect, by reducing the interest you pay on your mortgage, any savings you use to offset this mortgage will be earning the equivalent of 4.3%. Because you are actually saving yourself from paying interest, rather than earning it, you have no tax liability.

To get this kind of return on your savings in a standard savings account you would need to find one paying 5.4% if you are a basic rate tax payer or 7.2% if you are a higher rate tax payer, rates that are impossible to find in the current market!

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What are the advantages of offset mortgages?

• Not only does offsetting your mortgage mean you avoid paying a large chunk of interest overall, you can also use offsetting to shrink the term of your mortgage or to shrink your monthly repayments.
• Using your savings to offset your mortgage means they are not liable for tax on interest they would have earned in a standard savings account - the benefits are greatest for higher rate tax payers.
• Unlike overpaying your mortgage, putting your cash into an offset facility means you can withdraw it when you need it.
• Offset mortgage lenders calculate interest daily, so every pound you deposit works hard to reduce the cost of borrowing.
• Many offset mortgages allow lump-sum overpayments and do not apply early repayment penalties.

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What are the disadvantages of offset mortgages?

• Interest rates on offset mortgages are rarely the most competitive on the market.
• If you open a current account mortgage (see below) you need to be very disciplined with your finances. It’s essential to check regularly that you are in-line to pay-off your mortgage when you had planned.

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Types of offset mortgages

For most offset mortgages your savings will be kept in a separate account, with the same provider as your lender, and will be linked to your mortgage for the purposes of interest calculation.

However, you can also get an offset mortgage that utilises your current account, known as a current account mortgage (CAM), for example the One account (www.oneaccount.com), run by RBS. With CAMs, you get the same facilities as a traditional bank account, but your mortgage and current account are combined so you see just one balance.

For example, if you have £5,000 in your current account and you have a mortgage of £100,000, your statement will say you are £95,000 overdrawn.

The balance is calculated daily and you only pay interest on the net balance. You can transfer-in savings, and you can also transfer other debts such as credit cards and loans to the account, which will then typically accrue interest at the same rate as your mortgage. In this way, CAMs give you lots of flexibility with your finances. However, as you do not necessarily have to make set monthly repayments you must be very disciplined to ensure that you do pay off your mortgage within the term.

There are also products known as family offset mortgages. These allow parents to help their children get on the property ladder by offsetting their savings against their child’s mortgage.

For example, Lloyds TSB’s Lend-A-Hand mortgage requires that borrowers have a 5% deposit and that parents or other relatives hold savings worth 20% of the property’s value in a special account as security against the mortgage. They still earn interest on their savings, but it means that the borrower can benefit from the lower mortgage rates normally available to customers with a 25% deposit.

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Are my savings safe?

In the current economic climate, where bank collapses and bail-outs have become a reality, it is crucial to look at whether your savings would be protected if your bank collapses.

The general rule is that 100% of savers’ deposits up to £50,000 (for each financial institution) are fully protected by the Financial Services Compensation Scheme. (For a list of which banks and building societies share banking licences and so together count as a financial institution see our guide to safe savings.)

However, when you have savings and debts with the same institution, things become a bit more complicated…

In the case of banks, the situation is clear. Whatever the nature of your debts, whether credit cards, loans or mortgage debt, the total debt will be set against total savings before it is determined what compensation you are entitled to.

So, for an offset mortgage, your offset savings will be deducted from your mortgage to leave you with a total outstanding debt. You will receive no compensation but in theory, you are no worse off - you will have less accessible cash, but will have a smaller outstanding debt.

Building societies are different and have varying terms and conditions. In most cases, your debt will be offset by your savings but this depends on the terms and conditions set by your building society and which products you have with them.

In a worst case scenario, say you had a mortgage of £150,000 and savings of £100,000, your building society collapsed and in its terms and conditions stated it does not apply the offsetting rule. Your debt would remain the same, at £150,000 and you would only be eligible for compensation for £50,000 of your £100,000 savings so would have lost £50,000.

Currently, for all banks, and those building societies that do offset savings and debts, in the event of a collapse your savings, as long as they total less than your debts, are in theory 100% covered.

However, the FSA recently proposed changes to the way compensation is awarded, which, if approved, would result in savers receiving a “gross payout” in the event of a bank collapse. Because your savings would then be seen as separate from your mortgage and would not be offset against it, you would only be covered up to £50,000.

You should always read the terms and conditions and consult an independent financial adviser before choosing any mortgage product.

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Recommendation

Offset mortgages are a great way to maximise the value of your savings. Using your savings to offset your mortgage is likely to save you much more in interest charges than those savings would earn in a standard savings account.

However, offset mortgages don’t always offer the most competitive interest rates, so you are likely to be able to get a better rate on a traditional mortgage.

You need to do the sums before you decide which is best for you but offsetting will generally only leave you better off if you have a reasonable amount of savings or if think you will be able to save regular amounts that can be offset against the mortgage.

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