Mortgages can be difficult to understand, not least because there are so many different types. A property owner might, for example, take out a fixed-rate mortgage over five or ten years. Another might choose a variable-rate mortgage for a longer period of time, while some buyers opt for interest-only mortgages. UK readers can check the best deals on mortgages at Moneysupermarket.com
One type that almost always causes confusion initially is the offset mortgage, which is actually one of the least complicated types of mortgage available to property buyers in the UK.
What Is It?
An offset mortgage is simply a type of mortgage that offsets the savings of the mortgagor (this is the borrower and not the mortgagee, which is the bank or finance company that supplies the mortgage) against the debt or cost of the mortgage. This results in reduced interest payments.
A mortgage that offsets savings works in a simple way. It uses the sum of all savings (including cash held in a current account) to reduce the total mortgage debt. This has the effect of lowering the monthly interest payments.
If, for example, the mortgagor has £30,000 in savings and £5,000 in a current account, he or she can offset a total of £35,000 against the mortgage, the cost of which would reduce by exactly this amount. Instead of paying interest on a £305,000 loan, the mortgagor would pay interest on a mortgage of £270,000 (less his total savings).
This type of mortgage is obviously useful for saving money, but mortgagors need to calculate the relative savings very carefully to ensure that they are actually saving money. If the £30,000 in savings is subject to an exceptionally high rate of interest, the borrower might not want to offset this against a mortgage that is subject to relatively low rates of interest.
In the majority of cases, however, offsetting savings against a mortgage provides the property owner with a convenient way to reduce monthly outgoings. During times of economic uncertainty, this can be a sensible move.
The most obvious benefit of taking out this type of mortgage is that the mortgagor can reduce his or her monthly expenditure by reducing the interest paid on a mortgage. There are several other advantages, some of which may be less apparent.
If the mortgagor is no longer receiving interest on his or her savings, there will no longer be any need to pay tax on them. Reducing the tax burden on savings can be significant, especially if they are subject to the highest rate of tax.
Furthermore, interest rates on savings have been low for many years in the UK, whereas mortgage interest rates are relatively high. Substituting a small gain for a sizeable saving is clearly advantageous.
Another advantage of this type of mortgage is that the total debt is paid off sooner than would be the case if a normal mortgage were taken out instead. Clearing a mortgage as soon as possible is the most sensible way forward for property owners.