Article Summary

Offset mortgages are taking off, particularly among those in the higher tax bracket. What is an offset mortgage, and how do they work? Read on to find out.

Author: Anna Richardson

Offset mortgages have shaken up the mortgage market, as by far the biggest innovation in

One of the UK's largest lenders is of the opinion that 25% of existing mortgage holders would be best off with an offset mortgage. You could be in that 25%, so we suggest reading this article to find out what you could be missing out on.

What is an offset mortgage?

The essential idea is that while you are borrowing capital from the mortgage lender, you have savings alongside them. The idea is that you pay interest not on what you have borrowed but on what you have borrowed minus the amount in your savings account(s). For example, if you had an offset mortgage of £80,000 and had £15,000 in a savings account running alongside, you would only pay interest on the loan minus the savings, which makes £65,000. You will not, however, earn any interest on your savings; they will purely exist to offset the debt.

So what makes it so special?

Here's the thing – thanks to your savings, you pay a lot less interest on your mortgage account. You are not earning any interest on your savings, so you can't be taxed on any interest – which means that, especially if you have substantial savings, you are giving a lot less away to the taxman.

So people who typically have to give 40% of the interest their savings earn to the taxman will naturally be particularly attracted to the offset mortgage.

Consider the following calculations: assuming that you have a £100,000 mortgage over 25 years, paying a low interest rate of 4.69%, with a £20,000 deposit. With a normal mortgage you would pay £85,351 in interest but with an offset mortgage you would pay just £41,998 – the difference between those two figures is £43,353. Even better, you would repay the mortgage five years and eight months early because the monthly repayments are calculated on the full mortgage debt before your savings are taken into account. This means that you would be overpaying each month, resulting in early repayment.

In theory, on average a standard rate tax payer would make a saving of £9,538 in tax and a higher rate taxpayer a not to be sniffed at £17,341 in tax.

Another great advantage to the offset mortgage is flexibility – you can overpay without penalty, underpay and take payment holidays as long as you have built up enough surplus to cover any deficit.

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Did you Know?
If you smoke, the cost of your life insurance will be about double. And it's no use just giving it up a few weeks or months before you apply. Most life assurance companies say you mustn't have smoked for a least 12 months prior to the application – and some insurers extend this to 5 years!

Did you Know?
According to Land Registry figures, there has been a huge increase in the number homes sold for £1m plus. Despite what you'd expect, this hasn't caused the scramble for business you'd expect from lenders. Many of them are exercising caution when it comes to the well-heeled mortgage seeker. Surprisingly, the best deals go to the smaller borrower. It seem as if lenders would prefer to lend 10 borrowers £150,000 each rather than one loan of £1.5m, in order to spread the risk.

It is, however, beginning to get easier to get mortgage quotes for high value homes. Recent figures from the Land Registry show a massive increase in the sales of million pound plus properties.

Did you Know?
According to the Council of Mortgage Lenders, last year over 200,000 homes in the London area were financed by an interest only mortgage without a repayment vehicle being in place. Of these, 60,900 buyers were first-timers.

We cannot find national figures for the total number of homebuyers with interest only mortgages. However, the market share for interest-only mortgages has been running between 10 and 20% over the past 10 years.

Now it looks as if mortgage brokers have been arranging more than half of these interest only mortgages. So when these mortgages reach maturity, if the mortgage holder hasn't enough cash to repay the mortgage debt, many of these brokers could be up with a claim for miss-selling.

Did you Know?
A life insurance adviser must work for a firm that is authorised and regulated by the Financial Services Authority for what is called “insurance mediation”. Then, if you have a problem with the advice you were given, the firm has to undertake a formal review of your case. And if you are unhappy with their reply and you have lost out financially, you then have recourse to the Financial Ombudsman.