An offset mortgage works in a different way to a standard mortgage in that it’s not a single product. This clever idea first appeared in the late 1990’s.
It’s actually quite a simple idea and works very well for suited borrowers.
An offset mortgage works like this:
The Offset Lender calculates the total savings balance of the qualifying accounts that a saver holds with them. The total balance of a customer’s qualifying accounts is then set against their mortgage debt and a notional net figure calculated. A customer’s monthly mortgage payment is then calculated on this net figure.
So the balance of your savings is used to notionally reduce the mortgage balance and so you are charged less interest as a result.
This is a very useful position because the interest paid to savers on cash accounts is almost always less than Banks and Building Societies charge borrowers in interest on their mortgage account. In addition interest paid to savers is taxed. Under the Offset arrangement, however, savers give up their taxed interest on positive balances in exchange for paying less mortgage interest.
This is the equivalent of receiving interest on your savings at the same rate as you are paying on your mortgage, untaxed! Now that’s nice.
When this idea first appeared the taxman made noises about it as he thought it may be a tax avoidance type scheme. The courts took a different view on the basis that interest wasn’t ever actually being paid, the lender was simply charging less interest on the offset mortgage debt.
It’s easy to see that “offset” has real benefits for some borrowers.
Reduced term option
If a borrower takes this option, regardless of the amount offset and subject to interest rates changes, the monthly mortgage payments will remain the same. However, as there are savings in the linked accounts offsetting against the mortgage balance and a larger payment is actually made, more of the monthly repayment is used to pay back the capital element of the mortgage loan, which makes it possible shorten the term…………..saving thousands!
Reduced payments option
If a borrower chooses this option, the monthly mortgage payment could be reduced, whilst there is savings money in the linked account which is “offsetting”.
A borrower would have more disposable income, as the linked savings reduce how much they would pay monthly. The term of their mortgage would remain the same, however the borrower could again save thousands in interest payments.
- The account holder retains full control of their savings and can spend the savings if they wish. If money is spent there will be less to offset against the mortgage debt. It is possible to be in the position where you have as much money in savings accounts as you owe on the mortgage. At that time the net position would be nil and consequently no mortgage interest would be charged. With standard mortgages once a customer has reduced their mortgage debt, they generally have to re-apply to the lender to borrow it back if the need arises.
- Because the notional interest rate applied to savings accounts under offset is not taxable, it is equivalent to receiving a much higher gross interest rate on those savings.
Who should consider an Offset Mortgage?
- are higher rate tax payers and like to have cash available as part of their financial plan
- are self-employed and need to put aside the money for their tax bill
- may need to keep large amounts of cash available, such as property developers who have sold, but need money available to “go again”
- like the flexibility to drawdown pre agreed funds at will.
A point worth mentioning is that not all offset accounts are created equal.
How flexible the account is depends on the capabilities of each lender’s computer systems, so our mortgage advisers will invest some time finding out how you intend to use your account in order to ensure that your lender’s systems can deliver what you need.