Offset mortgages explained: how linked savings cut your interest

An offset mortgage links your savings to your mortgage. Instead of earning interest, the savings reduce the balance you are charged interest on: with £250,000 borrowed and £30,000 in linked accounts, you pay interest on £220,000. The money stays yours and stays accessible. Offset mortgages are common in the UK, and Australia has a similar offset account. Whether one saves you money depends on your savings balance, your tax position and the rate you are offered, which is what the offset mortgage calculator compares. It is general information, not mortgage advice.

How an offset mortgage works

Each month the lender works out interest on the mortgage balance minus the money in your linked savings and current accounts. You do not earn interest on those savings; the benefit comes as interest you are not charged. Your monthly payment is usually set as for a normal repayment mortgage of the full amount, so because less of each payment goes on interest, more goes towards the balance, and the mortgage is paid off sooner. If your savings go up or down, the offset changes with them, month by month. How mortgage amortization works, and why overpaying early matters explains the split between interest and capital that this shifts.

A worked example

Take the calculator's defaults: a £250,000 mortgage at 4.8% over 25 years, with £30,000 of savings offset throughout.

• The normal monthly payment is about £1,432.
• Without an offset, total interest over 25 years is about £179,748.
• With £30,000 offset and the same payment, the mortgage is paid off about 3 years 4 months early, and total interest falls to about £121,878, a saving of about £57,870.

The saving is large because the offset works every month for the whole term, and because the extra capital repaid early stops attracting interest too. The calculator assumes the savings balance stays constant, which real balances rarely do; a pot that grows over time saves more, and one you spend saves less.

Shorter term or lower payment

Lenders usually let you use the offset in one of two ways. Keeping the normal payment, as above, shortens the mortgage. Alternatively, some lenders will recalculate the payment as if you owed only the balance minus your savings over the full term: in the example, about £1,261 a month instead of £1,432. The first option saves more interest; the second frees up cash each month. You can often switch between them, and the mortgage calculator shows how the payment changes with balance and term.

Offsetting vs a savings account

The fair comparison is the interest you avoid against the interest you would earn after tax. In the first year, £30,000 offset against a 4.8% mortgage avoids about £1,440 of interest, and because it is interest saved rather than earned, there is no tax on it. The same £30,000 in a 4% savings account earns £1,200 before tax. In the UK, the Personal Savings Allowance lets basic rate taxpayers earn £1,000 of interest tax-free and higher rate taxpayers £500, with none for additional rate taxpayers, so how much of that £1,200 you keep depends on your tax band and other savings. A higher rate taxpayer paying 40% on all of it would keep £720. The calculator uses a single tax rate on savings interest, so enter your effective rate. As a rule of thumb, offsetting wins when your after-tax savings rate is lower than the mortgage rate.

The catches

• Higher rates and fees. Offset deals are often priced slightly above the best standard mortgages. A rate 0.3 percentage points higher on the whole balance can wipe out the benefit of a small savings pot, so compare total cost, not just the offset saving.
• Discipline. The savings only help while they stay in the linked accounts.
• Fewer products. Fewer lenders offer them, which narrows your choice when remortgaging; the refinance calculator helps compare a switch.

Who it suits

Offset mortgages tend to suit people with a sizeable savings balance they want to keep accessible, higher rate taxpayers who would lose much of their savings interest to tax, and the self-employed who set money aside for tax bills during the year. They suit people with little or no savings much less well. Building a cash buffer first with the savings goal calculator and then reviewing the options with a broker is a reasonable order of steps.