Guide to Offset Mortgages
"Neither a borrower, nor a lender be," Polonius advised Hamlet, but that was before the advent of offset and current account mortgages.
Nowadays, being both a borrower and a lender can work to your advantage with these types of mortgage, but only in certain circumstances.
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How current account and offset mortgages work
A current account mortgage combines a mortgage with one or more of a current account, a savings account, credit card and an unsecured loan, all within one account. This means that you have all your credit balances offset against your debit balances, with interest being charged on the net balance only.
An offset mortgage works in a similar way, but each account is separate, although the various accounts are linked and your credit balances are offset against your debit balances, with interest charged on the net balance only.
Most recent product launches have been offset mortgages, rather than current account mortgages. But in either case, if you have a mortgage of £100,000 and savings of £8,000 with the same provider, you would only be charged interest on the net balance of £92,000.
The linked accounts offered will vary between providers, but most will offer a current account with an overdraft facility and a savings account. Some providers will permit you to have more than one savings account if you so want, but unsecured loans and credit cards are now less common as part of offset packages.
As with traditional mortgages, offsets are available in an array of different forms, so you can take your choice from fixed, tracker or discounted initial interest rates. The key advantage with offset banking is that interest on credit balances is effectively paid untaxed, or gross, because it is paid at the same rate as the underlying mortgage.
In practice, this is achieved by way of offsetting it against the interest payable on the mortgage, rather than actually receiving the interest.
People selling offset mortgages generally stress that the benefit of offsets apply over the longer term and will produce graphs to show you how much quicker your mortgage can be repaid than a normal mortgage based on various assumptions.
Who should consider offset banking/mortgages?
- Higher rate taxpayers because they will get maximum benefit from their credit balances because they would normally be taxed at 40 per cent
- People with significant levels of savings
- The self-employed and people who have lumpy income (such as intermittent or annual bonuses) because the flexibility of offset allows them to manage their income flows and to meet their tax payment obligations.
- Buy-to-let landlords because offsets allows them manage their portfolios more easily.
- People wanting the flexibility of offsetting
What are the advantages of offset banking?
Interest on credit balances earns untaxed gross interest because any savings or salary that you pay into the offset account will reduce your mortgage debt and therefore the amount of interest payable on the mortgage.
This means that if you are financially disciplined, it may be possible to repay your mortgage more quickly than with a conventional mortgage.
Some lenders will permit friends or relations to offset their savings against your mortgage, allowing them to keep control of their savings, while reducing the interest payable on your mortgage.
The interest rate (or "revert to" interest rate) at the end of any initial introductory rate period is, for many current offset mortgages, a tracker linked to a margin above the Bank of England base rate and this often compares very favourably with the standard variable rate of conventional mortgages.
Another advantage is that if you are committed to offsetting over the long term, you won?t face the hassle or expense of having to remortgage periodically.
Offsets also tend to have flexible features, such as permitting overpayments, underpayments or payment holidays (but note that some non-offset mortgages also offer these features).
Other factors to consider
Interest rates charged on offset mortgages tend to be slightly higher than their non-offset counterparts. This differential has narrowed considerably in recent years and some lenders no longer charge a premium for certain products.
Offset banking does not suit everyone and there's no hard and fast rule as to who will benefit from it.