You might have heard that term offset mortgage thrown about before on TV adverts, news articles, and in your local bank. But how much do you really know about offset mortgages? What are they and why would anyone choose to offset their mortgage? In this article we will explain what an offset mortgage is, how they work, we will go through the pros and cons of securing an offset mortgage and, how to best prepare for getting one.
What is an Offset Mortgage and How Does It Work?
In the UK, offset mortgages are far from the most common type of mortgage. In fact, the majority of lenders do not offer them. However, this does not mean that they are going extinct, and it certainly doesn’t mean that they can’t be beneficial. Because mortgage lenders who offer this type of mortgage are somewhat few and far between, finding a clear and concise definition can be tricky.
So, what is the best offset mortgage definition? Simply put an offset mortgage is a type of mortgage that is linked to one of your savings accounts. Don’t worry, your savings won’t be taken away and used to pay off your mortgage. Instead, they will lower the interest you’ll be charged on your repayments each month. Simple enough? So how does an offset mortgage work?
Mortgage lenders will essentially deduct the amount you have in savings from your mortgage balance. You will then pay interest on what’s left. This means you will pay less interest than if you had a regular repayment loan. Because of this, your monthly mortgage payments could be less. With low repayments it will take you longer to pay off your mortgage. If you want to increase or decrease the payments even more, you can change the term of the mortgage or interest rate you are paying.
Is an Offset Mortgage worth it?
Let’s put this in to practice with some hypothetical numbers. Imagine that you were buying a property for £500,000 and getting a mortgage of £250,000 and you take the mortgage for 25 years at a rate of 2.22%. On a straightforward capital repayment and interest mortgage, you would pay £1,087 per month.
Now imagine that you have £50,000 in personal savings in a UK bank account. You could potentially offset that £50,000 you have in savings against the loan so essentially you would only be paying interest on £200,000 of the loan. This would potentially reduce your monthly payments by £106 a month and could save you £31,812 in interest over the 25-year term of your mortgage.
Of course, all these figures are just an example and not necessarily applicable to everyone’s circumstances. We would always recommend that if you are interested in an offset Mortgage, you should always have your figures checked by a qualified and experienced mortgage advisor first.
Some Offset Mortgage Pros and Cons
As with any home finance scheme, there are multiple positives and negatives to taking out a offset mortgage that your mortgage advisor will explain to you in detail and carefully consider. Below are some one the ones that we think you should know about.
- The savings you will make on interest will work out more than the interest earned from just keeping a regular savings account.
- You still have access to your savings and are free to dip in and out of them in at any time you like.
- You can link an ISA to your offset mortgage meaning that you can use an account that offers tax-free interest payments as well as any other kind of saving account.
- You can choose to increase your monthly payments and pay off your mortgage quicker if you like.
- You should get lower monthly payments if that is what you are interested in due to the mortgage being partly offset against your savings.
- You could help a family member buy a property with an offset mortgage by offsetting your savings against their mortgage if you wanted to.
- You pay no tax on the interest you save over the term of your mortgage– You may have to pay tax on interest earned on a normal savings account unless it is an ISA as mentioned above.
- You won’t earn interest on your savings if you use them to offset your mortgage.
- If you draw from the savings, you’re using to offset your mortgage, your monthly payments could increase. For example, if you use 50% of your savings up then you have lost that part of the offset so this will be added as interest to the monthly payment.
- There can be higher offset mortgage rates. Most lenders who offer offset mortgages have rates from 2.2% upwards whereas a regular capital and interest repayment mortgage could be as low as 1%.
- You may need a bigger deposit for an offset mortgage. Because they are few and far between, the lenders who do offer an offset mortgage often require a minimum of 25% deposit but potentially more whereas you can potentially put down as little as 5 or 10% deposit on a regular mortgage.
- Your savings account and mortgage will be with the same bank or lender. The mortgage lender will require your savings to be kept in an account with them so that they can monitor and link your savings account to your mortgage.
- Some lenders will ask for a minimum amount of savings to secure an offset mortgage. Some lenders will say that you must have at least 15 or 20 thousand pounds to even be considered a suitable customer.
- As we’ve mentioned several times, there’s not a huge number of lenders who offer offset mortgages, so the market is very limited.
Who Offers Offset Mortgages?
There are hundreds of building societies and banks across the UK who offer property finance however only a small number currently offer offset mortgages. At the moment, these lenders are:
- Barclays Bank
- Santander Bank
- NatWest Bank
- Yorkshire Building Society
- First Direct Bank
- Clydesdale Bank
- Accord Mortgages
- Scottish Widows Bank
- Hinckley & Rugby Building Society
- Chelsea Building Society
- Coventry Building Society
- Halifax Bank
- Virgin Money
- The Family Building Society
Each bank or building society will have their own mortgage affordability and customer criteria that you must meet as well as their separate offset mortgage criteria. Before your mortgage advisor submits an application for you, they will research each lender that offers offset mortgages and will find the best lender for you. Not using a mortgage professional to help you arrange your mortgage with the correct lender could put you at risk of being declined if you don’t meet their criteria.
Types of Offset Mortgages
So far, we have only spoken about straight forward residential offset mortgages however there are different types of offset that people can take out and here are a few of them:
- Family Offset Mortgages
In a family offset mortgage, the total amount borrowed is reduced by the value of the parents’ savings. The children do not have to have any money in savings themselves (other than their own deposit potentially) By offsetting the parent’s savings against the mortgage, this lowers the loan to value so that the overall debt is smaller, and interest rates are lower, which in turn reduces the cost of the repayments.
- Buy-To-Let Offset Mortgage
Exactly in the same was as a residential offset mortgage, you would offset your savings against the buy-to-let mortgage balance to reduce the amount of interest you pay on part of the loan. The intention being that this will increase your net profit from renting the property out and the offsetting increases the amount of money you have coming in from rent and reduces the amount you have going out from the mortgage payments. You could secure this kind of loan on either a repayment or entirely interest only basis.
- Interest-Only Offset Mortgages
Although these are perhaps the least common variation of offset mortgage, you can still secure a completely interest only offset mortgage. Just like any other interest only mortgage, you will pay just the interest rather than capital and interest back to the lender. By offsetting a part of the loan against your savings you will only pay interest on the part of the loan not offset. Because it’s still an interest-only mortgage and you won’t have paid any of the loan capital back, you will need to have a way of paying back the loan at the end of the mortgage term in its entirety. This is called a repayment vehicle and your mortgage advisor will help you to arrange this at application stage. Typically, you can’t offset a mortgage against rental income that you are receiving.
- Fixed and Variable Rate Offset Mortgages
Like most other mortgages, you can get either a fixed or a variable rate offset mortgage loan. A fixed mortgage is fixed at a certain rate for normally a period of 2 – 5 years but can be as many as 10 years with some lenders. This means that the repayment interest rate will be fixed for a period of time and will not change. A variable rate loan is a mortgage which is not fixed and can change depending on things like lender preferences and the Bank of England base rate increasing and can change at any time. This means that your mortgage rate could be 2.5% one week and 4.5% the next. Despite this risk, some people prefer to stay on the variable rate as their rate could remain low and they have more flexibility if they aren’t tied into a fixed product.
Flexible Offset Mortgage
The good thing about offset mortgages is that they can potentially be flexible. By this we mean that the key feature of an offset mortgage is the ability to reduce the interest charged by offsetting a credit (Savings etc..) against the mortgage debt, with interest charged based on the outstanding net debt rather than the fixed and less flexible parameters of a normal mortgage.
If you are looking for a mortgage and are looking for more flexibility in your borrowing and repaying the loan, perhaps a flexible offset mortgage could be for you. Only by speaking with a qualified mortgage advisor and talking through your options, will you find out if a flexible offset mortgage is right for your circumstances.
Preparing for an Offset Mortgage Guide
If you are thinking about getting an offset mortgage, then there are a few things that you need to think about and prepare for before you start the application process. All of these things will be explained to you by your mortgage advisor and their administration team who will help you with everything.
- Like any other kind of mortgage, you will need to make sure that your credit file is in a good position. When applying for any kind of mortgage you would ideally want your credit score to be good and to not have any missed or late payments showing on it. Things like defaults, County Court Judgements, IVAs and Bankruptcy are all potentially mortgage threatening credit issues that most mortgage lenders will not allow at all. As there is a limited amount of offset mortgage lenders currently in the market, you want to make sure that your credit file is clean and strong so that you have the best chance of getting a mortgage with one of these lenders. If it isn’t, you could risk being ineligible for a mortgage. If you are concerned about your credit file, you can check your credit score for free.
- Make sure that all of your income documents are available and not unusual. It might seem like something straight forward but unfortunately since the market crash of 2008 and more recently the COVID-19 pandemic, mortgage lenders have become increasingly strict on acceptable income proofs and types. Generally, if you are an employed PAYE person who pays tax in the UK, the mortgage lender will need to see your 3 most recent payslips and potentially a p60 if you receive any bonuses, commission, or overtime. If you are a self-employed sole trader, they will want to see your last two years tax overview and tax calculation documents which show clearly your net profit after tax. In most cases, the lender will take an average of the two years as your overall income. If you are a self-employed share holding company director, they will normally need your last two years full company accounts showing your salary, dividend, and profits from the business. It is likely that your income will fall in to one of these categories but if you are unsure, you can always ask your advisor what the lender will need to see.
- Make sure all bank accounts are suitable and your credit commitments are not excessive. Mortgage lenders will generally want to see three months bank statements from all bank accounts that you use to make sure that they can see your income coming in from a reliable and proper source. They also want to see that your credit commitments are not outweighing the income that you have coming in. By that, we mean that the mortgage lenders do not want to see more money going out of your account on things like loans, credit cards, school fees etc…. than money coming in from your job. If you have too many credit commitments your mortgage affordability will be severely impacted and could be declined. They will also use this as proof of deposit if it is coming from savings. If you are unsure about this, your mortgage advisor can look into this for you.
- Proof of identification and residence is very important and can be a stumbling block if not considered early on. All mortgage lenders will need to see some form of proof of ID. This is usually a passport or UK driving licence. If you are not a UK national, you will need to have permanent right to reside, and some lenders will need you to have been in the UK for a number of years.
Offset Mortgage Specific Requirements
- As well as having to save a deposit and potentially stamp duty if you are not a first-time buyer and have proof of this money, you will also need to prove that you have enough money in savings to cover the offset. As we mentioned above, the upper amount that you can offset your mortgage for is essentially limitless. However, most offset mortgage lenders will need you to have a minimum amount in savings to begin with meaning that you could need to have quite a large amount of savings behind you. Some lenders stipulate that you need a minimum of 15-20 thousand pounds. They also often require a much larger deposit contribution from yourself than if you were getting a standard capital repayment and interest mortgage.
- After speaking to a mortgage advisor and deciding which lender you are approaching for your offset mortgage, you will need to set up a savings account with that lender and transfer the savings that you are using to offset the mortgage to that account. If you do not have your savings in an account with the same lender as your mortgage, they will be unable to monitor your savings and the savings on interest that you are making.
If you are looking for a new mortgage, there are many avenues that you can go down. Not all will suit you and your circumstances, and some will be completely irrelevant to what you are looking to do. But maybe…just maybe, an offset mortgage might be the best option for you. If you have a healthy amount in savings and you want to keep your monthly mortgage costs down then it may be worth considering however, you won’t truly know if it is a good idea until you seek the help of a mortgage professional to go through the pros and cons.
At Oportfolio, our advisors and mortgage administration team are experts in offset mortgages, and we have helped guide many clients over the years on how best to make the most of their mortgage and personal finance. If you or someone you know is interested in a potential offset mortgage or any other kind of mortgage or remortgage, then please feel free to contact our friendly and helpful team to see how we can help.