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Are you considering paying off your mortgage early? You may want to consider an offset mortgage, widely understood as a great way for homeowners to pay off their mortgage ahead of time.
The essential principle of an offset mortgage is simple. Your savings are set against your mortgage debt and instead of earning interest on your savings, no interest is charged on the same amount of your mortgage.
Over the lifetime of a 25 or 30 year mortgage this can save you thousands of pounds and is highly tax efficient. Read on to see how the offset system works.
How offset mortgages work
A lot of mortgage borrowers will also have savings, even if they are small, using this money to cancel out mortgage debt makes a lot of sense.
Savers avoid paying tax on interest that their deposits would otherwise have earned. And because offset mortgage lenders calculate interest daily, every pound on deposit works hard to reduce the cost of borrowing.
Not to mention the fact that in a low interest rate environment, any savings you have are effectively earning interest at a higher rate than most mainstream savings accounts will pay.
With interest only paid on the balance between savings and mortgage debt you achieve the same effect as overpaying a homeloan: but the beauty is you can get the money back if you need it.
Current accounts, savings and offset mortgages
Some offsets allow you to link current accounts and savings balances to the mortgage, while others just use a savings pot. They can be described in different ways, but essentially both work the same.
When offset mortgages were first around rates were often substantially higher than on normal homeloans. This difference no longer has to exist and offsets from providers such as First Direct can actually beat normal mortgage rates.
In the simplest type of offset deposits are kept in separate accounts or ‘pots’, but linked for the purposes of interest calculation.
If you put more money on deposit your balance reduces, if you withdraw it then it increases.
The pure offset mortgage
The way the offset facility on the Scottish Widows Professional Mortgage works is very simple — much simpler than that offered by most other mortgage providers. A savings account (Offset Saver Account) is set up alongside your mortgage.
The money in your savings account is ‘offset’ against your mortgage. This means that you won’t earn any interest on your savings, but you won’t be charged any interest on the same amount of your mortgage — as shown by the diagram below.
This could potentially save you thousands of pounds in interest and you can benefit from this in one of two ways:
- Paying off your mortgage early (we call this reduced term), or;
- Reducing your monthly mortgage payment.
Option 1 – Reduced term
If you choose this option, your monthly mortgage payments will always stay the same – subject to changes in interest rates. However, because the savings in your Offset Saver Account are offsetting against your mortgage, more of your monthly payment is used to repay the balance of your mortgage – which makes it possible for you to pay off your mortgage sooner. And you could save thousands in interest payments too.
The table below gives a specific example of the offsetting benefit reduced term could help you achieve.
|Amount of savings offset against mortgage||£15,000|
|Monthly mortgage payment||£824.44||£824.44|
|Total amount payable||£247,284.27||£208,583.32|
|Amount of mortgage Interest saved||£38,763.09|
|Mortgage term reduced by||3 years 11 months|
Option 2 – Reduced monthly payment
If you choose this option, your monthly mortgage payment could be reduced, giving you more disposable income. This is because the savings in your Offset Saver Account are used to reduce how much mortgage interest you would normally pay each month. The term of your mortgage remains the same.
The table below shows how you could benefit from reduced monthly payments.
|Amount of savings offset against mortgage||£20,000|
|Monthly mortgage payment for initial variable rate period||£607.92||£519.75|
|Total amount payable||£178,852.15||£155,087.45|
|Amount of mortgage interest saved||£23,764.70|
|Mortgage term reduced by||0 years 0 months|
Important information about reduced monthly payment
With reduced monthly payment as your offset benefit, your mortgage payments will be adjusted from your second mortgage payment – your first mortgage payment will always be collected in full. On an ongoing basis, your offset benefit will be calculated for each full calendar month and your mortgage payment will then be adjusted accordingly at the end of the following month. We’ll write to you each month to advise you how much your next mortgage payment will be.
Current account mortgages
The first offset mortgages launched in the UK were current account mortgages (CAMs), linking a homeowner’s current account with the mortgage.
With CAMs, the bank account and mortgage were combined so customers view just one statement and see one balance. For example, if there is £2,000 in the current account and the mortgage is £80,000, the customer’s balance will register £78,000 overdrawn.
The balance is calculated daily and the homeowner pays interest only on the balance. CAMs offer the same services as an ordinary bank account. Customers can also add any savings into the CAM account to reduce the debt balance. Any other debts, such as personal loans or credit cards, can be transferred to the account. The homeowner, typically, pays the same interest rate across the lot.
How an offset mortgage differs from a repayment mortgage
With both types of offset, borrowers usually make a regular monthly repayment, though this may not be strictly necessary. For repayment mortgages, this guarantees that the mortgage will be repaid at some future point, regardless of the offset.
Any savings above that are offset against the loan and reduce the interest charged on the mortgage. This means that the borrower is effectively overpaying on monthly repayments and effectively reducing the overall term of the mortgage.
Within limits, offset deals also allow homeowners to draw more funds at any time without having to remortgage. And lump-sum overpayments may be made without penalty.