An offset mortgage is a combined savings and mortgage account. They sound confusing, but we’re big fans. They can be incredibly useful if your work produces temporary surges in cashflow, some of which you need to reinvest later.
If you’re a company director, self-employed, a locum healthcare professional, or anyone else with a lumpy cashflow and income, then they can make enormous sense. They’re even better if you’re a higher rate taxpayer. Read on to learn more….
What is an offset mortgage?
In essence, they’re simple:
- A savings account – provided by your mortgage lender
- A linked mortgage account – provided by the same lender
- Interest rates – are the same on both savings and mortgage accounts
- Savings – the balance of the savings account is subtracted or offset from the mortgage
- Withdrawals – You can withdraw cash, usually on 24 hours notice, and use it to cover your business, or home cash demands.
Confused – sounds complex?
Even ordinary mortgages can be baffling and frustrating. The process of getting one is made more stressful by complex jargon, and what can often seem arcane requirements. First-time-buyers particularly, can be daunted by the risks of taking on a large loan and dealing with big and unfriendly, financial institutions. For many, the added features of offset mortgages can be a confusing step-too-far.
That’s why you should speak to a mortgage broker to help guide you through the process. We can make things simple and stress-free: advising you on whether an offset mortgage might make sense. Our job is slash through the jargon, assess your needs and find the best and cheapest mortgage for you. We can run the numbers on an offset mortgage to see if it fits your needs.
Offset mortgages were traditionally only available from private banks for their high-net-worth customers. But they have now moved into the mainstream. There are a number of lenders who offer offset products, usually based on variable rate or tracker mortgages. But there are some fixed rates available too. Of course, there are far fewer offset mortgage products available than straight conventional mortgages. We can advise you about the best product to suit your needs and how to secure the lowest offset mortgage rate with the best terms.
Here are some of the lenders who are offering offset mortgages at the time of writing:
|Accord Mortgages||2 -5yr fixed up to 90% LTV|
|Barclays Bank||Tracker rates up to 75% LTV|
|Clydesdale Bank||Variable rates up to 80% LTV|
|Coventry Building Society||2 -5yr fixed up to 75% LTV|
|Family Building Society||Variable rates up to 80% LTV|
|Scottish Widows Bank||2 – 5yr fixed up to 90% LTV|
Flexibility – The benefits for the self-employed and company directors
We think you should definitely consider an offset mortgage it if your employment generates large and lumpy cashflows, and especially if you’re a higher rate taxpayer. For instance if you’re a company director, partner in a business, self employed, a locum healthcare professional, barrister or partner in a professional business.
Offset mortgages can then provide you with amazing flexibility. Let’s assume you often receive irregular payments from your business or clients and later have to make large tax, investment, or expense payments. That means that cash has to be easily available and can’t be put into volatile investment accounts with long, withdrawal processes.
The advantage of the offset mortgage is that you can deposit cash straight into the linked savings account, which is then offset against your mortgage, reducing the interest that you pay. That cash hasn’t disappeared or been locked up – it’s there to withdraw, usually with 24 hours notice, whenever you wish. in the meantime, it’s earning interest at the same rate as your mortgage and that can have enormous tax benefits that you can see described below.
Reassurance and security
Running your own business or being self employed can be stressful. And large financial companies can seem uninterested and unsympathetic. Whether in mortgages, pensions, or investments, financial products have often been invented by and for people in employed jobs with a full salary, and little risk.
Offset mortgages are the exception. They’ve been designed for those with uncertain cash needs and sometimes unpredictable demands. They’re one of the few financial products that give risk-takers more safety. You can enjoy the reassurance of knowing that you have committed borrowing available through your mortgage, whenever you need it. And a safe, high interest and tax effective home for your cash in the meantime.
Higher interest rates
Until recently, savings rates have been notoriously poor. Even now, with higher base rates, savings rates are usually 1% to 3% lower than mortgage rates. Of course, it is possible to find higher interest savings accounts, but that usually means locking away your cash for a fixed term. And there are heavy withdrawal penalties if you need your cash early.
Offset mortgage savings accounts don’t have those disadvantages. The savings rate that you earn by offsetting is the same as your mortgage rate. And there are no penalties for withdrawing cash at any time.
Of course these benefits can change depending on market conditions and with changes in your circumstances. So it’s always worth checking what savings rates are available at any particular moment and we can help you do some simple breakeven calculations to see what makes sense for you.
Big potential tax benefits
Probably the biggest financial benefit, particularly for higher or additional rate taxpayers, is that offset mortgages can effectively allow you to earn tax-free interest. Let’s compare the tax treatment of a savings account to an offset mortgage to see why:
- Savings accounts will usually pay interest without deducting tax.
- If you pay tax by PAYE then you’ll usually be taxed on that via deductions to your salary. Banks report interest payments to HMRC who will adjust your tax code accordingly.
- As a higher rate taxpayer you’ll pay the full rate of tax on an interest since your other income will have already used up any tax free or basic rate allowances.
- So a high headline rate of interest can be reduced by 40 to 45% by tax.
- ISAs – do allow you to save tax-free up to £20,000 each year. But withdrawing cash is only possible until the end of the tax-year and even then may incur penalties and early withdrawal charges.
- Offset mortgages offer complete flexibility, for much larger amounts of savings and allow you to effectively pay zero tax on the interest.
- The only limit on how much you can save is the size of your mortgage.
- Any cash you place in the savings account reduces the interest payments on your mortgage.
- That saving is a reduction in costs not a form of income and so is not taxable.
- So the interest you earn is effectively tax-free.
- For higher rate tax payers the difference can be dramatic.
- And you still have the flexibility to withdraw cash whenever you need it without penalties, charges or the loss of any allowance.
Of course offset mortgages aren’t right for everyone. There are disadvantages that mean that they might not make sense for you:
- Higher rates – in general, you’ll pay more for an offset mortgage. Expect interest rates that are 0.2% to 0.3% higher than an ordinary mortgage. You could argue that also provides some benefit since you also get higher rates on your savings but plainly net-net, it’s a cost.
- Excess cash – you don’t need to be saving much in your offset savings account before it becomes more cost-effective than an ordinary mortgage. But that’s only true if you have the excess cash to spare and more true still if you’re a high-rate taxpayer.
- Fees – we can probably find you an ordinary mortgage with low or no upfront fees, paid to the lender. But expect to pay slightly more for an offset mortgage. And such fees are usually a fixed amount, not a percentage. So even though the fee can normally be added to your loan, it’s proportionally much more expensive for if you’re borrowing smaller amounts.
- Less choice – there are literally hundreds of mortgage lenders available to you in the UK market with thousands of products. But the number offering offset mortgages is a much smaller fraction. So that other features that you’re looking for such as a particular fixed rate may be harder to achieve.
- Bigger deposit – there are very few offset mortgages which don’t require at least a 25% deposit, sometimes more. A few are available with as little as a 10% deposit but with stricter terms and eligibility.
- Large loans – Lenders can restrict certain offset mortgages to only borrowers taking out larger loans. Smaller offset mortgages are possible buty may lack other features you’d want.
- Adverse credit – offset mortgage lenders will expect to see a relatively clean credit record. Frustrating though that it is, it does actually make sense. Since offset mortgages are really only suitable if you have excess cash and are not struggling financially.
This is where an experienced broker comes in. We’ll crunch the numbers, consider all factors, and scour the entire UK mortgage market to find the best deal tailored just for you. Interested? Sign up here to begin.
Who shouldn’t get an offset mortgage?
Offset mortgages offer clear benefits for certain people. But they’re not right for most. They are probably not worth considering if you’re:
- A first time buyer, unless you’re a high-earner with irregular excess cash
- On a low income
- Have a weaker credit profile
- Are struggling to prove affordability for the size of mortgage you want
- You’re a higher earner but with a fixed salary, permanent employment and few unpredictable costs
Our advice then would be to start out with the simplest and most affordable mortgage product available. We will be able to guide you through the process to the mortgage best suited to you. In such cases there are other better alternatives to offset mortgages thjat can have some of the same advantages.
The best alternatives for those not suited to an offset mortgage
Even if you don’t take out an offset mortgage, then you can still get some of the benefits with a mainstream loan, perhaps combined with other investment products:
- Overpayments – Many mortgages, particularly fixed rate will have early repayment charges that could be as high as 5% in the first year. However almost all now allow you to make up to a 10% annual overpayment each year, sometimes 20%. An overpayment is essentially an early repayment of the mortgage principal.
- Repayment flexibility – If you want total flexibility then speak to us about loans that have no early repayment charges whatsoever. They’re mainly variable rate and tracker. Others offer the same flexibility after an initial period of discount or fixed rates.
- Investment planning – taking out a mortgage is often a good time to think about your long-term finances more broadly, making a will and thinking through your insurance and protection needs. We can help and advise on all of these matters.
- Regular saving – into an investment account or can offer high compounded returns over the decades. We can’t offer advice on investments for regulatory reasons, but would be happy to recommend investment advisers that can,
- Pensions and ISAs – offer significant tax benefits which compound in value over the years. Remember that property is one way to save for long-term security and stability but it’s not the only way and may not be the best for you.
How to calculate the potential savings with an offset mortgage
Calculating the value of an offset mortgage and whether it’s well suited to your financial situation, can be complex. It depends upon interest rates, your cahs situation and tax bracket. But some mortgage lenders provide really useful calculators that simplify the process. You can find some of them below: