Offset Mortgage
There are several different types of offset mortgage, but the general principle is the same in terms of the benefits they can give.
Typically, you would have a mortgage account and a savings account.
The lender's system knows how much money you have in your savings account and mortgage.
You are not charged interest on the balance of your mortgage that equals the amount in your savings account.
For example, if you have a mortgage balance of £100,000 and a savings balance of £25,000 you will only pay interest on £75,000 of the mortgage balance.
For ease of explanation, imagine you have an interest-only mortgage, and the interest on a £100,000 mortgage, at an example 5% interest rate, would be £417 a month.
If you had £25,000 in the offset savings account, you would still pay £417 a month (as your mortgage balance is £100,000) but you are only charged interest on £75,000 of the mortgage.
You are NOT charged interest on £25,000 of the mortgage, as this is the amount you have in your offset account.
Of your £417 mortgage payment; £313 is interest due on £75,000.
The other £104 will be applied to your mortgage balance, and that month, your mortgage would reduce from £100,000 to £99,896.
Ignoring interest rate changes. your monthly mortgage payment would remain the same, regardless of how much money is in the savings account.
Because your mortgage payment remains the same, your mortgage is effectively being overpaid, with the result that the mortgage will be paid-off earlier.
An offset mortgage is especially valuable to a higher-rate taxpayer, as there is no tax to pay on the return on your savings.
This is because the savings account receives no interest. Your return is, instead, by way of a reduction in your mortgage balance.
You therefore get a tax free return on your savings equal to the mortgage interest.
