What is an offset mortgage?
There can be more than one way to buy your next home if you lack finances. There are numerous types of mortgages with various mortgage lenders. One type of mortgage is offset mortgage.
If you have savings sitting in a bank account, you can use that money to offset your mortgage. We will shortly get to what that means in detail, but essentially you can use your savings to pay less interest on your mortgage.
This article, which is part of a series of articles on conveyancing, takes a closer look at offset mortgages and how offset mortgages work. Further, it discusses what mortgage rates you should expect to pay with an offset mortgage and whether you can use your savings to offset your child’s mortgage. Towards the end, it will summarise the pros and cons of offset mortgages so you can determine whether an offset mortgage will suit you.
How does an offset mortgage work?
In an offset mortgage, the lender will consider how much savings you have.
You will be charged interest on the difference between your savings and your total debt, resulting in lower interest repayments.
Example of an offset mortgage
For example, if you took out a mortgage for £200,000 at 3% interest and offset it with your savings account that has £30,000, you will only have to pay interest on £170,000. In the long term, you will save thousands of pounds which would otherwise be going towards interest payments.
Can you access your savings offsetting your mortgage?
A considerable advantage of an offset mortgage is that you can access your savings when needed. This is not only easier but also significantly cheaper than your other options, such as remortgaging, for times when you need extra cash.
However, any withdrawals you make will affect your mortgage. Either your monthly payments will rise, or it will take longer to pay off the debt, resultantly costing you more in the long term.
Further, you cannot move those savings to earn interest. This is a drawback you should consider when deciding whether an offset mortgage is right for you.
The tax efficiency of offset mortgages
By using your savings to offset your mortgage, you forgo the interest you could earn in a savings account.
This will work out in your favour if the current savings rates are lower than the going mortgage rates.
What are the drawbacks of offset mortgages?
Aside from the drawback that you can’t use those savings to earn interest, your mortgage repayments will go up if you withdraw an amount from the savings. So you have to decide whether you can afford to lock up your savings for a long period.
In simple words, offset mortgages are not for everyone. However, they are a more popular choice amongst people who are already in the higher tax band. Further, an offset mortgage can also benefit you in other ways.
How else can you benefit from an offset mortgage?
Aside from the savings you will make annually on interest repayments, generally, mortgage lenders offer customers a choice between paying the debt over a short term or a longer-term (by making lower monthly payments).
This is since mortgage repayments are based on your total debt (and not the offset amount).
What does it mean for borrowers?
Practically, this means that borrowers overpay each month, thereby reducing the time it takes to pay off the total debt.
However, resultantly, your mortgage term could be cut by months or even years, depending on your savings.
Further, the higher your savings, the less interest you have to pay. Generally, you should have 20%-25% of the total mortgage amount in savings.
What are the types of offset mortgages?
Offset mortgages can have a fixed interest rate or variable interest rate. There is a substantial difference between the two that has been covered in our article on types of mortgage.
You should choose according to your circumstances and on the advice of your mortgage broker.
What should you expect to pay in mortgage rates with an offset mortgage?
Typically, interest rates for offset mortgages tend to be slightly higher as compared to other types.
However, it also depends on whether you choose to make small monthly repayments or quickly pay the debt over a short term. Generally, the faster you pay off your mortgage, the better off you are likely to be in the long run.
Family offset mortgages
Some mortgage lenders allow for parental savings to be offset against a child or a close family members’ mortgage. These are called family offset mortgages.
How family offset mortgages work?
Family offset mortgages work in the same way as other offset mortgages while also allowing the parent to retain full control of their savings.
The parent will have to incur the opportunity cost of investing their savings to help their children climb the property ladder without recourse to a large gifted sum of money.
Offset mortgages pros and cons
If you are a diligent saver, an offset mortgage may sound like the way to go. However, offset mortgages do not always work out to be cheaper, even if you have a lot of money saved up.
Advantages of offset mortgages
- It allows you to potentially pay off your debt early or pay it back over a longer-term, thereby reducing your monthly payments.
- You can still access your savings
- If the current savings rate is lower than the mortgage rates, the amount you will save on interest payments will exceed the amount of interest your savings would earn in a savings account.
- You can reach the threshold in savings interest without incurring the liability of a higher rate taxpayer.
Disadvantages of offset mortgages
- If your savings are offsetting your mortgage, you will not earn any interest on your savings.
- Your mortgage will be affected if you make withdrawals from your savings.
- The Loan to Value ratio is generally lower for offset mortgages. This means that you will have to pay a higher deposit. Most offset mortgage deals require a deposit of up to 25% of the property’s value.
- The offset mortgage market is tiny when compared to the conventional mortgages market. So you might find it harder to locate a deal or mortgage rate that is suitable to your needs.
You may also be interested in learning about how to make a successful mortgage application and what you should do if your mortgage has been declined.
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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