- They are suitable for homeowners sitting on a significant amount of savings.
- Offset mortgages use the power of cash savings to reduce the interest on home loans.
- Offset mortgages aren’t offered by all lenders and they also have many drawbacks.
Last 18 months in the pandemic period was an ideal time to buy a house with the Boris Johnson government’s lucrative incentive like the stamp duty holiday --- meaning no tax on the first £500,000 of properties. Many Britons have bought houses in this period. The yearly house price growth went up to 13.4% in June, marking the strongest growth since November 2004, as per the Nationwide Building Society.
There are many ways one can buy homes or avail home loans. One of the ways is offset mortgages. Offset mortgages empower homeowners to use the power of cash savings to pay less interest on their home loans. This type of mortgage suits borrowers who have extra cash on them, especially at a time when banks are paying low interests on fixed deposits or similar schemes.
Offsetting can also be a quicker route to mortgage freedom, trimming months (or years) off the term of a home loan. Many people, however, are still unaware about the benefits of offset mortgages. In this article, we will see how these mortgage work and who all can avail it.
How offset mortgage works
The interest which needs to be paid by the homeowners on home loans can be reduced with the help of an offset mortgage, which is basically using the power of cash savings to offset the interest.
Under the offset mortgage system, the savings of the borrower are held in an account, which is linked to their mortgage arrangement. Contrary to earning interest on their savings, as in case of saving accounts in banks, the savings are used to reduce the amount of interest that is to be paid on the home loan.
The savings are not actually used to pay back the mortgage amount, but to sit along with the mortgage arrangement. To better understand this arrangement, let’s take an example, considering a mortgage worth £100,000, and savings worth £20,000. In this case, by offsetting the £20,000 savings, you have to pay the interest on the remaining £80,000 of the debt only. The monthly capital repayments continue to be paid by the borrower as defined by the terms of the offset deal.
What are its benefits?
Even though the savings become a part of the mortgage arrangement, there is still the flexibility to access them whenever needed. But the withdrawal of savings will have a see-saw effect on the arrangements, as the mortgage interest payments would rise if money is withdrawn, and vice versa. A notable point is that this flexibility comes at a cost, as the interest rate applied to the traditional home loan arrangements tends to be lower than the offset mortgage interest rate. But the savings are being put to a good use under this system, as the money isn’t lost and can be accessed anytime.
Another benefit of offsetting is that it offers a choice to the customers between making lower payments per month and repaying the borrowed amount over a relatively shorter mortgage term. The Financial Services Compensation Scheme provides protection to the deposits that are held in the linked offset savings account. If a bank or building society fails, a compensation worth up to £85,000 per person, per institution, is provided to the savers under the scheme.
Suitable borrowers for offset mortgage
Not everyone is suitable for offset mortgages. Only the borrowers who are sitting on a significant chunk of savings are. A financially secure person with a significant equity stake in their property is the most favorable customer for offsetting mortgages. Offset mortgage option may be a temptation for the future mortgage customers who are about to receive a lump sum amount of money, such as inheritance.
However, the borrowers who have set aside their savings for any forthcoming purchase or project, should choose the traditional mortgage, as their cash can be then spent imminently and be put to productive use. The first-time home buyers who don’t have enough cash at hand cannot benefit from offset mortgages. However, these home loans may be used by parents to support their children in getting onto the property ladder.
How to apply
You can get an offset mortgage by directly applying to a provider. However, the options available as lenders would be comparatively less, as offset mortgages are not as conventional as traditional home loans. Coventry and Yorkshire building societies offer offset mortgage scheme. Besides, Barclays which is the banking giant, and the banking arm of life insurer and pensions provider Scottish Widows.
Mortgage brokers play a key role in the process, and they help the borrowers in carrying out an extensive research of the market. After analysing the current circumstances of the borrower, the mortgage brokers identify the suitable offset mortgages for them, explain their functioning to them, and help them explore all their options of lenders providing these mortgages. The payments are made to these brokers by either the borrower paying the fee they charge for their service, or by the chosen lender giving them commission.
Types of offset mortgages
As in the case of traditional home loans, the two major types are interest-only and repayment. The original borrowed amount (the capital), and additionally, the rate of interest on that amount, is needed to be paid by the customers under the repayment arrangement. But in the case of an offset arrangement, the savings of the borrower are linked to the mortgage account.
The interest-only mortgages are not as popular now as they used to be earlier. In these mortgages, only the interest, and not the capital is repaid by the customers. The capital is in turn repaid at the end of the mortgage term, and thus, it is the requirement of lenders that the would-be borrowers have laid out a repayment plan in advance. The affordability checks of the lenders essentially need to be passed by the borrowers in case of interest-only mortgages, just like the application for a repayment deal.
Another type of offset mortgages is on the basis on interest rate: fixed and variable. The borrowers are offered an option to choose between them in standard mortgages. In case of fixed interest rate, the interest amount that is charged on the capital is invariable, even though there can be fluctuations in the interest payments on the basis on the savings amount in the offset arrangement.
On the other hand, the variable interest rate is generally tracking an economic indicator, like the Bank of England base rate, or it may even relate to the standard variable rate of the lender.
A major contrasting point between standard and offset mortgages is that cash is readily accessible in case of offset mortgages when needed. This is not usually possible in case of standard alternatives, as they allow only limited overpayments for borrowers per year, which is also cuts the interest. But the homeowners are required to make a plea to their lenders as well as engage in affordability checks, in case they need their money back.
What are its drawbacks?
As mentioned above, not all homeowners are suitable for offset mortgages, due to higher interest rates associated with them, and not all lenders offer these mortgages. Even if you have a significant cushion of cash, you may not get any returns on your savings that are held in an offset-linked account. Considering the individual overall circumstances, it may be better for some borrowers to keep their savings in a traditional deal and get a relatively lower mortgage rate that way.
It is very important to conduct a meticulous research and analyse the costs and benefits of committing to any deal, considering the best suitable options as per your financial condition. Mortgage arrangements can be assessed with the help of online comparison tools too. The offset home loan may prove to be the suitable option for you only if you are certain that your savings can be held in the account untouched and if you can benefit from the lower overall mortgage debt, even at a higher than normal interest rate.