Offset mortgage deals offer you the chance to save time or money on your mortgage, but very few of us understand them. Here's what you need to know - and whether they are right for you.
When the topic of offset mortgages comes up, many glaze over and head off into the sanctity of a daydream. Very few of us have the first idea how they work, who they are best for, and what to look for from them. All we know is that they are a bit complicated.
Don't take my word for it - research from First Direct has found that almost half of homeowners do not understand the basic principle of an offset, and just one in five of us believe it can save us money on our mortgage.
But offsets can help you cut either your mortgage term or your monthly payments - so sit back, and stay alert! This could save you a bundle!
What is offset?
An offset mortgage works by using your savings to - you guessed it - offset your mortgage.
You have two different versions - a standard offset mortgage and a current account mortgage.
Let's start with a standard offset deal. Say you have a mortgage of £150,000, a savings account with £20,000 and a current account with £5,000. With an offset mortgage, you would typically take out all three accounts with your mortgage lender, and 'link' them.
As a result, the £25,000 sitting in your savings account and current account actually reduces the amount you owe on your mortgage. It's like an old-fashioned weighing scales of debt and credit - the amount of money you have in credit at the bank is balanced against the amount of debt you owe, with the result that you effectively owe £25,000 less debt.
This means you only have to pay interest on the remaining mortgage balance of £125,000, and can choose to have smaller monthly payments, or reduce the term of your mortgage.
The current account mortgage, typified by Royal Bank of Scotland's One Account, works in a very similar way, but actually combines your mortgage and current account into a single account. So using the example above (and supposing you moved your savings into your current account), your account would show that you were in deficit by £125,000, and that is the sum that you would pay interest on.
Typically the lender will stipulate a minimum amount that must be added and left in the account each month in order to repay the mortgage over your agreed period. Should there be more money in the account than agreed, then you will pay less interest and pay off your mortgage earlier! So each £1 you keep in your current account is helping to reduce your mortgage debt.
You can also transfer other debts, such as credit cards and loans into a current account mortgage, and pay a single rate of interest.
Offsets don't have to be taxing!
A big benefit of offset mortgages is that they are tax-efficient. With the example above, you are no longer paying interest on £25,000 of your mortgage. As a result, you are essentially saving £25,000 at the rate of your mortgage, but without having to pay any tax on it. Tax-free saving - now that can be a significant benefit, especially if you're a higher-rate taxpayer.
The products are also worth their weight in gold for the self-employed, who have to spend all year putting money aside for their tax bill anyway. Why not use those savings to cut your mortgage payments or your mortgage term?
A downside to consider
Of course, there is a catch. By using your savings to offset your mortgage, you will no longer receive any interest on them. However, you can access the savings at any time and move them around - a flexible feature missing from some of the top-end savings accounts.
And given the frankly rubbish rates of interest many savings accounts are paying at the minute, it may make more sense for you to use those funds to reduce your mortgage payments instead.
Just be aware that offset mortgages also require a fair amount of discipline.
While you benefit from having £100,000 sitting in savings, should you decide to treat yourself to a particularly expensive impulse buy, then that will have a pretty detrimental effect on your mortgage.
Is an offset right for me?
It goes without saying that an offset is not right for everybody - not all of us have a stash of savings that we can put aside for a start!
As a rule, the products are best for those with either sizeable savings, or very healthy paycheques. However you really need to do a little maths to work out if the deal is right for you.
Handily, lovemoney.com have our own offset calculator to help you work out how much you could save by opting for an offset!
The best rates
A quick glance at the best buy tables reinforces the fact that these products are best for those with a bit of cash. The market leading deal is from Woolwich, offering Bank Base Rate plus 1.99% for the lifetime of the mortgage, but is only available to those with a whopping 40% deposit.
For those with a smaller deposit of 25%, First Direct may be worth a look, offering a deal at Bank Base Rate plus 2.39% for the term of the mortgage.
There are clear dangers in opting for any product that tracks Base Rate at the moment, as Christina Jordon explains in Protect yourself from mortgage rate hikes. However, very few providers offer a fixed rate on offset deals, and those that do charge a bit of a premium - for example, the cheapest deal is again from First Direct at 2.99% for two years, though this then jumps to Base Rate plus 3.19% for the remainder of the mortgage.
The biggest negative of an offset product is the perceived complexity. To get the most out of an offset, you really have to engage with the product, checking your accounts on a regular basis to ensure that you are maximising your return from the product. It also requires a fair amount of discipline.
But if you can devote the time and effort into making the most of an offset, and have the funds behind you, then in my opinion there are very few better options.
More: Eight Amazing Offset Mortgage Deals | Protect yourself from mortgage rate hikes