Cut your monthly mortgage payment and clear your mortgage 5 years early!

Find out the clever way to beat rubbish savings rates, and make far better use of your spare cash.

Those of you with a chunk of savings must surely be getting frustrated with the appallingly low rates on offer right now. Worse still, a relatively high rate of inflation is only eating away at the real value of your cash. Of course, it’s always sensible to put some money aside for emergencies, but many of you must be wondering whether there’s really any point in saving any more.

But what if you could put your cash to far better use, and still get your hands on it whenever you need to?

Offset mortgages versus tax-free savings

If you’re a mortgage borrower, and you have a spare lump sum, you could make your savings work a whole lot harder with an offset mortgage. In fact, an offset mortgage could even be a better home for your savings than a cash ISA.

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But getting a decent deal from your ISA is a little more difficult to achieve than you might imagine. After all, just one third of the 307 cash ISAs available offer rates above 3%, according to financial research company, Defaqto. Worse still, many of these accounts demand you lock your savings away for several years, or apply harsh withdrawal penalties. In fact, the average tax-free return is just 2.40%.  

How does offsetting work?

Before we look at how offsetting could save you money, here’s a brief summary of how it actually works.

You link a savings account to your mortgage. By doing so, you reduce your outstanding mortgage balance by the total sum of your savings - as long as you keep those savings in that account. For example, imagine you have a mortgage of £120,000 and savings of £20,000 in a linked savings account. By offsetting, you’ll only have to pay interest on a mortgage of £100,000. Effectively, for as long as you keep that £20,000 in the bank, you are borrowing £20,000 less, which can save you a lot of money in interest over the term of your mortgage.

And crucially, you’ll always retain full access to your savings, which you can withdraw from your linked account whenever you need to. Just remember, when you withdraw the savings you use for offsetting, you’re effectively increasing your mortgage debt and will have to start paying more interest again. In this way, the amount of interest you have to pay each month is likely to fluctuate as the savings balance you use to offset your mortgage changes.

It's also worth bearing in mind that you won’t earn any interest on the savings you use for offsetting - instead, you'll be saving yourself interest payments at the interest rate of the mortgage. So as long as your mortgage rate is higher than the net interest rate you are earning on your savings, you'll be quids in. Note that I said 'net interest rate' (i.e the rate you would earn after tax) because the more tax you normally pay on your savings, the greater the benefits of offsetting.  (To figure out your net interest rate if you're a basic rate taxpayer, multiply your gross interest rate by 0.8, and if you're a higher rate taxpayer, multiply it by 0.6.)

Recent question on this topic

• welshlady asks:

  Have offset mort 3.65%, trying to pay off toasap, thinking of 0% credit card and using funds to offset Can you trf funds from c.card into account? x

  • 
    MikeGG1 answered "Some 0% cards do allow it, but charge an extra amount the priviledge. Maybe 4% instead of..."
  • 
    Swarbs answered "Also remember that if you use a 0% card to clear the mortgage you will have only 12-16 months to..."
  • Read more answers

How could offsetting benefit you?

So how much better off could you be with an offset mortgage? Take a look at this example from Defaqto:

If you had a mortgage loan of £100,000 with a rate of say, 2.74% and £20,000 held in a linked savings account, you would only have to pay interest on £80,000 using an offset facility. This would have the effect of saving more than £14,000 in interest, and you’ll get the additional benefit of cutting back your mortgage term by five years into the bargain.

But if you put your £20,000 lump sum into a Cash ISA paying an average return of 2.40% instead, your return would be less than £12,000. So by offsetting, you could save yourself over £2,000 and clear your mortgage early.

So even if your mortgage rate is pretty low, with savings rates on all sorts of accounts as dismal as they are now, the case for offsetting is even more compelling. For example, big offset mortgage player, First Direct explains that with their current standard offset mortgage rate - which is 3.69% with an overall cost for comparison of 3.8% - a higher rate taxpayer would need to earn a rate of 6.33% on their savings just to get the same benefit as offsetting. Meanwhile, a basic rate taxpayer would need a return of 4.71%, while non taxpayers need 3.75%.

I don’t think I need to tell you it’s virtually impossible to earn rates this high in today’s savings market, even with a tax-free cash ISA.

So, when the interest earned on your savings is likely to be lower than the amount of interest you pay on your mortgage debts, offsetting could be advantageous. But remortgaging, or taking out a new offset mortgage, is never a decision you should take lightly. The benefits of offsetting may not be quite so pronounced should savings rates significantly improve, and you'll also need to take the costs of setting up the mortgage into account. To help you find out whether an offset mortgage could save you money, speak to one of our fee-free lovemoney.com mortgage brokers.

But, finally, to give you a taste of what’s on offer first, here’s a selection of the lowest rate variable and fixed rate offset mortgages available today:

Top offset mortgages: variable rates

And now for the fixed rates:

Top offset mortgages: fixed rates

Source: Moneyfacts

More: Top mortgage deals whatever your deposit | The cheapest way to sell your home

At lovemoney.com, you can research all the best deals yourself using our online mortgage service, or speak directly to a whole-of-market, fee-free lovemoney.com broker. Call 0800 804 4045 or email mortgages@lovemoney.com for more help.

This article aims to give information, not advice. Always do your own research and/or seek out advice from an FSA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article. 

Finally, we tend to only give the initial rate of a deal in our articles, but any deal which lasts for a shorter period than your mortgage term will revert to the lender's standard variable rate when the deal ends. Before you take out a deal, you should always try to find out from your lender what its standard variable rate is and how it will be determined in the future. Make sure you take all this information into account when comparing different deals.