If you’re a taxpayer with savings – or even just plans to save – then an offset mortgage could be right up your street.
Offset mortgages are quite complex products, which is why you may not have heard of them before.
In simplest terms, an offset mortgage allows you to offset your savings against your mortgage debt.
Imagine it like a balancing scales. At one end, you have your savings. At the other end, your debt. The two help to balance each other out. That’s the principle of an offset mortgage.
Here’s a worked out example:
- You have £10,000 of savings, which you are earning 4% interest on with Bank X.
- You have a £200,000 mortgage, which you are paying 5% interest on with Bank Y.
With an offset mortgage:
- You would have to move your savings to an account with Bank Y, your mortgage lender. Then you would earn nothing on your savings. The money would simply sit in your bank account, accessible whenever you need it, but not earning any interest.
- Because of this, for as long as your £10,000 of savings sits in your bank account, the size of your mortgage debt would be reduced from £200,000 to £190,000.
This would mean that you would have less interest to pay on your debt, and could either:
- Keep your payments the same, enabling you to pay off your mortgage quicker and therefore saving thousands of pounds in interest payments over the mortgage term. You would also become mortgage-free much earlier in life.
- Reduce your payments, but keep the term exactly the same and pay off the mortgage in the time you intended to pay it off.
You can use our offset calculator to figure out how much you can save.
Tax implications
An offset mortgage is an extremely tax-efficient way to save money, particularly for high-income earners. Here’s why:
As explained above, with an offset mortgage, instead of earning interest on your £10,000 of savings, you are no longer being charged interest on £10,000 of your mortgage debt. So, effectively, you are saving at the rate of the mortgage (so in the example above, 5% instead of 4%).
But even though you are saving yourself money at this rate, you are not earning anything - you are paying off debt. So you do not have to pay any income tax.
This means you are saving at the rate of the mortgage, tax-free. To get an equivalent return as an offset mortgage offers at 5% to a higher-rate taxpayer, you would have to find an instant access savings account paying 8.33%.
No easy feat!*
Self-employed borrowers
Offset mortgages are particularly beneficial for self-employed borrowers. This is because self-employed borrowers must save all the year long to pay for their tax bill in January. While you are saving, you can offset this money against your mortgage and reduce your monthly payments – a nice little bonus from the taxman!
*At the time of publication, when most savings accounts were paying around 4% to 5%.
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