Offset Mortgages Explained: What Is an Offset Mortgage And How Do They Work?

In the world of mortgages, having savings can often leave you with a choice: keep the money readily available or use it as a deposit to pay down your mortgage.

An offset mortgage offers another approach and allows your savings to help reduce your mortgage interest, while remaining available to withdraw. This can be useful on many levels, keeping money for planned home improvements, an upcoming tax bill or simply safe for any future unexpected expenses.

However, offset mortgages are not automatically cheaper. The mortgage rate, your savings balance and the interest your money could earn elsewhere can all affect whether an offset mortgage could offer you good value.

In this article, we explain exactly how offset mortgages work, how much interest you could save and the benefits and drawbacks you need to consider when deciding whether one is right for you. Let’s begin.

How Does an Offset Mortgage Work?

To understand how an offset mortgage works, it can be helpful to think of your mortgage and savings as two separate pots of money.

Your savings will never be used to physically repay your mortgage. Instead, the lender deducts the balance held in your linked mortgage offset account from your outstanding mortgage before calculating the interest you owe.

To show how this works in practice, let’s take a look at an example of an offset mortgage:

• Outstanding mortgage: £250,000
• Linked savings balance: £50,000
• Balance charged interest: £200,000
• Mortgage rate: 5.00%

On a standard mortgage loan, you would typically pay 5% interest on a £250,000 balance. This would equate to approximately £12,500 over one year, assuming the balance remained unchanged.

However, with £50,000 held in the linked savings account, the interest would instead be calculated on £200,000. Using the same example, this would equate to approximately £10,000 over one year, saving £2,500 a year.

In our example, the £50,000 savings balance remains separate from the mortgage balance of £250,000. However, offsetting the savings has reduced the amount of mortgage interest charged by approximately £2,500 over the year.

It is important to note that how the actual savings affect your loan will depend on the mortgage product.

Some arrangements may use the lower interest charge to reduce your monthly repayments. On the other hand, you may be able to choose to keep your monthly payment broadly the same, meaning more of each payment goes towards reducing the mortgage balance and could help you repay the loan sooner.

Your savings are held in a linked account with the mortgage lender, which will typically work much like an easy-access savings account.

As such, you can usually withdraw your money whenever you need to. However, doing so will reduce the amount available to offset against your mortgage and will naturally increase the interest you pay.

Are There Different Types of Offset Mortgages?

Standard Offset Mortgage

A standard offset mortgage links your own savings to your mortgage, usually through a savings account that will be held with the same lender.

Instead of earning interest on those savings, the money is used to reduce the interest that is charged.

Put simply, the more money you keep in the linked savings account, the smaller the balance used to calculate your mortgage interest. For example:

• Mortgage balance: £200,000
• Linked savings: £30,000
• Balance charged interest: £170,000

In this example, the lender would only calculate mortgage interest on £170,000 for as long as the £30,000 remained in the linked savings account.

The benefit is that your savings remain separate and can still typically be accessed whenever you need. However, if you withdraw some of the £30,000, there will be less money available to offset against the mortgage and the amount of interest you pay will increase.

Family Offset Mortgage

A family offset mortgage works in a similar way to a standard offset mortgage, the only difference is that the savings linked to the mortgage belong to a family member rather than the borrower themselves.

This type of arrangement is often used as a way for parents or relatives to help someone buy their first home without the need to permanently gift away their savings. For example:

• Mortgage balance: £250,000
• Family savings linked: £40,000
• Balance charged interest: £210,000

In this example, the borrower would still only pay mortgage interest on £210,000 for as long as the £40,000 remained in the linked account.

The £40,000, however, would still belong to the family member and would not be used to repay the mortgage.
Once again, the owner of the savings will usually be able to access their money whenever they require, although withdrawing some or all of it will reduce the amount being offset and increase the mortgage interest charged.

Offset Buy-to-Let Mortgage

An offset buy-to-let mortgage works in much the same way as a residential offset mortgage, but the borrowing is secured against a rental property rather than your own home.

Any eligible savings held in the linked account are then used to reduce the balance on which mortgage interest is calculated.

For example:

• Buy-to-let mortgage balance: £300,000
• Linked savings: £75,000
• Balance charged interest: £225,000

In this example, the landlord would only pay mortgage interest on £225,000 for as long as the £75,000 remained in the linked savings account.

This type of mortgage can appeal to landlords, property investors or higher-net-worth borrowers who want to utilise large cash reserves but still want to keep that money accessible.

With that said, offset buy-to-let mortgage products do tend to be less widely available than residential offset mortgages, and so the range of lenders and deals can be more limited.

How Much Interest Could I Save?

There is no single figure or amount that you will save with an offset mortgage. In reality, every mortgage agreement is different and the total savings will vary depending on how your mortgage and savings balances change throughout the mortgage term.

With that said, we can demonstrate how much you could potentially save on mortgage interest using a simple example.

Let’s assume you have a £250,000 mortgage with an interest rate of 5%.

If the mortgage balance remained unchanged for one year, we can compare different linked savings amounts to show how the potential interest saving could change:

As the table shows, the more money you hold in the linked savings account can help to reduce the amount of your mortgage that is charged interest.

However, it is important to keep in mind that these figures are only illustrative. In reality, mortgage balances can reduce over time on a repayment mortgage, savings balances can rise or fall, and interest rates may change depending on your specific mortgage deal.

An offset mortgage calculator can give you a more personalised estimate by comparing your specific mortgage balance, interest rate and savings.

Using an online mortgage calculator can be a useful starting point when deciding whether keeping your money in savings could provide more value than using it to reduce the mortgage directly.

Which Mortgage Lenders Offer Offset Mortgages?

Offset mortgages are a specialist mortgage product and so fewer lenders will generally offer them compared with standard residential mortgages. As a result, the number of available products and providers can be more limited than with a standard mortgage deal.

Some of the main lenders that are currently offering offset mortgages include:

• Accord Mortgages
• Barclays
• Coventry Building Society

It is important to note that mortgage products and lender availability can change regularly, so this list should only be treated as a current guide.

While these lenders are among the more prominent offset mortgage providers at present, it is always worth checking the latest products, rates and eligibility criteria with your chosen mortgage broker before applying.

Additionally, when considering which banks offer offset mortgages, it is important, these products are not limited to banks. Building societies, such as Coventry, can also offer offset mortgage products.

How Are Offset Mortgage Rates Calculated?

Your set rate will depend on many factors, including your chosen lender and the individual mortgage deal you qualify for.

In addition, your deposit or equity can also play an important part in the interest rates that are available to you, as this determines your overall loan-to-value (LTV) ratio.

Crucially, the amount held in your linked savings account will not usually have any direct effect on your mortgage rate itself. Instead, the amount simply reduces the mortgage balance that the rate is applied to, which can lower the total interest you end up paying.

For example, if you had a £250,000 mortgage at 5% with £50,000 held in linked savings, the 5% mortgage rate would remain the same. However, the lender would only apply that rate to £200,000 while the full £50,000 remained in the account.

As a general rule, offset mortgage rates can be slightly higher than the interest rates that you may see available on standard mortgages.

As such, it is important to look at the potential interest saving from your offset account alongside the mortgage rate itself when comparing deals.

Beyond the rate itself, offset mortgages can also differ in how the interest rate is structured, how you repay the mortgage and which accounts can be linked.

Interest Rate Type

Offset mortgages can come with either a fixed or variable interest rate, and the best way to think about these types of rates is by comparing predictability against flexibility.

A fixed interest rate will provide you with more predictability, as your mortgage rate will remain the same throughout the agreed product term.

A variable rate offers less predictability, as your interest rate and monthly repayments can move over time. However, this also means you could benefit if rates fall, although your repayments could increase if rates rise.

When comparing the type of interest rates, it can actually help to separate the mortgage rate itself from the offset feature.

The rate type determines whether the interest rate stays the same or can change over time. The offset feature then reduces the mortgage balance that this rate is charged on.

It is important to keep in mind that your savings will not change the type of interest rate you have. They will simply reduce the amount of mortgage that the set rate applies to.

To understand how your interest rate type impacts your offset mortgage, here’s what it means in practice:
If you had a £200,000 mortgage and £40,000 in linked savings, you would only pay interest on £160,000.

What happens next depends on your rate type:

• Fixed rate: The interest rate charged on that £160,000 would remain the same for the agreed fixed period.
• Variable rate: The interest rate charged on that £160,000 could rise or fall over time.

In both cases, your £40,000 savings are doing the same job. They reduce the balance on which interest is charged, while your chosen rate determines how predictable or flexible that interest will be.

Ultimately, the choice often comes down to what you find the most comfortable to manage. A fixed rate offers more certainty, while a variable rate can offer more movement, for better or worse, depending on how interest rates change over time.

Repayment Structure

An offset mortgage can be arranged on either a repayment or interest-only basis, depending on the lender and product.

In both cases, your linked savings will reduce the amount of interest charged, but the way you repay the original mortgage balance will be different.

With a standard repayment mortgage, each monthly payment goes towards both the interest charged and the original amount you borrowed.

Alternatively, an interest-only offset mortgage will work slightly differently. While your linked savings will still reduce the balance on which interest is charged, your regular monthly payments do not reduce the original amount borrowed and the capital will still need to be repaid at the end of the mortgage term.

As with any interest-only mortgage, you will need to have an acceptable repayment plan in place to repay the outstanding mortgage balance at the end of the term.

As the table shows, the main difference between repayment structures is whether your monthly payments also reduce the capital you originally borrowed.

Linked Accounts

The number of accounts that can be linked to an offset mortgage will depend on the lender.

While some lender criteria will stipulate that only a single savings account can be linked, other lenders may allow several savings accounts to contribute towards the total offset amount.

This means that, rather than relying on just one pot of savings, some borrowers may be able to combine balances across multiple linked accounts to reduce the mortgage balance on which interest is charged.

For example, if you had £20,000 in one linked savings account and £10,000 in another, a total of £30,000 could potentially be offset against your mortgage.

It is important to check with your lender which accounts you are able to link, who can hold those accounts and whether there are any restrictions on accessing the money during your mortgage term.

Is an Offset Mortgage Worth It?

Unfortunately, there is no simple yes or no answer to whether an offset mortgage will be a suitable mortgage option as each borrower will have their own unique property goals and financial circumstances.

As a general rule, it is best to weigh the potential interest savings and flexibility against considerations like the mortgage rate, potentially lost savings interest and more limited lender choice.

For those who have a sizeable amount in savings, an offset mortgage could help reduce the mortgage interest they pay significantly, while still allowing them to keep access to their money.

However, for others, the benefit may be much smaller. Particularly if the savings balance is low, regularly withdrawn or the offset mortgage comes with a higher rate than an alternative type of mortgage.

The best practice is to look at the whole picture of pros and cons, rather than just the offset feature on its own. For example:

The Pros and Cons of an Offset Mortgage

Looking at the offset mortgages pros and cons side-by-side can make it much easier to understand where they could offer value and where they may not.

Ultimately, the value of an offset mortgage comes down to whether the interest you save outweighs what you could achieve with another mortgage and savings arrangement.

This is why an accurate comparison needs to consider both sides of the equation: the mortgage rate you would pay and the return you could otherwise earn on your savings.

How Can I Compare Offset Mortgage Deals?

To create a good offset mortgage comparison, you will need to look at your mortgage and savings together, rather than focusing solely on a specific mortgage rate.

One of the most important questions is whether the interest saved through offsetting will provide enough value to justify the mortgage deal itself.

For example, it is worth comparing the interest you could save through offsetting against what the same money could potentially earn elsewhere. A competitive savings account may sometimes provide a better return, depending on the interest rate available and your individual tax position.

When comparing your options, you should consider:

• Mortgage rate: Compare the rate against other offset deals and suitable standard mortgages.
• Potential interest saving: Consider how much you realistically expect to keep in the linked savings account.
• Savings interest: Compare your offset saving against the interest your money could earn in a separate savings account.
• Mortgage fees: Include arrangement fees and other product costs when comparing the overall deal.
• Linked account rules: Check how many accounts can be linked and whose savings can be included.
• Access to savings: Understand how freely you can withdraw your money and what happens to your offset benefit if you do.
• Early repayment charges: Check whether early repayment charges could apply if you repay or switch the mortgage during the product term.

Your personal tax position can also play a role in comparing the value of an offset mortgage. This is because linked offset savings will generally not earn interest, and so there is usually no savings interest from that account to tax.

Because linked offset savings do not earn interest, you do not receive any taxable savings income from those funds. For higher-rate and additional-rate taxpayers who risk exceeding their annual Personal Savings Allowance through standard savings accounts, offsetting can effectively provide a tax-free equivalent return equal to your mortgage interest rate.

As such, while it is important to note that this does not make an offset mortgage a tax-free product, it can affect how the overall value compares with keeping the same money in a separate interest-paying savings account.

Ultimately, when you compare offset mortgages, the lowest interest rate will not always mean the best deal for you.

Instead, it’s crucial to look at how the mortgage rate, fees and potential offset saving work alongside each other and what your savings could earn elsewhere.

How Can a Mortgage Broker Help Me Understand My Options?

As we’ve explored throughout this article, comparing offset mortgages can sometimes be a little more complicated than simply looking for the lowest interest rate.

You also need to consider the savings balance, linked account rules, mortgage fees and what your money could potentially earn elsewhere.

This is where working with an experienced mortgage broker can help you decipher fact from fiction.

At Boon Brokers, our advisers can compare mortgage products from across the whole market and assess the different rates, fees and product features available to you.

We will help you understand how much you could potentially save through offsetting and whether another type of mortgage may offer better value for your situation.

You will have your own dedicated mortgage adviser as a single point of contact throughout the process. They will be on-hand to answer all of your questions, explain your options and will manage your application from start to finish.

Our mortgage advice is completely fee-free, meaning you will not pay a broker fee for our advice or for arranging your mortgage.

If you are considering an offset mortgage or want to learn more about your mortgage options, contact Boon Brokers to speak with one of our fee-free mortgage advisers today.