Offset Mortgages: How They Work

What Is an Offset Mortgage?

An offset mortgage links your savings account (and sometimes your current account) to your mortgage. Instead of earning interest on your savings, the balance is 'offset' against your mortgage debt, reducing the amount you pay interest on.

For example, if you have a mortgage of £200,000 and savings of £30,000 in a linked account, you'd only pay interest on £170,000. Your savings remain accessible, but instead of earning interest, they work to reduce your mortgage interest.

Offset mortgages are offered by a number of UK lenders, though they're less common than standard fixed or variable rate deals. They can be available on fixed, tracker or variable rate terms.

How Does the Offset Work in Practice?

Each month, your lender calculates the interest on your mortgage balance minus your linked savings balance. You still make your full monthly payment as if the savings weren't there, but because you're being charged less interest, more of each payment goes towards reducing the capital.

This means you'll pay off your mortgage faster than you would without the offset, even though your monthly payment stays the same. Alternatively, some offset mortgages allow you to reduce your monthly payment instead, keeping the mortgage term the same but lowering your outgoings.

Your savings remain in your account and you can withdraw them at any time. However, if you reduce your savings balance, the offset benefit decreases and you'll pay more interest going forward.

Who Benefits Most From an Offset Mortgage?

Offset mortgages tend to benefit higher-rate and additional-rate taxpayers the most. Because you don't earn interest on your savings, you also don't pay tax on that interest. For a higher-rate taxpayer, offsetting can be more tax-efficient than earning interest in a standard savings account.

They're also useful for self-employed borrowers or anyone with irregular income who likes to keep a large cash buffer. Rather than having savings sitting idle in a low-interest account, offsetting puts that money to work reducing your mortgage costs.

If you have substantial savings relative to your mortgage balance, the interest savings can be significant. However, if your savings are modest, the benefit may not outweigh the typically higher interest rates charged on offset products.

Disadvantages of Offset Mortgages

Offset mortgage rates are often higher than equivalent standard fixed or tracker rates. This premium means the offset only provides a net benefit if your savings are large enough to more than compensate for the higher rate.

You won't earn any interest on the savings linked to your offset account. If savings rates are particularly high, you might be better off keeping your savings in a high-interest account and taking a standard mortgage at a lower rate.

Fewer lenders offer offset products, which means less competition and potentially fewer deals to choose from. The application process can also be slightly more complex than a standard mortgage.