With savings rates at a record low, an offset mortgage can save you thousands of pounds.
Following six consecutive reductions in the base rate, the vast majority of savers have been left earning next to nothing.
By contrast, mortgage rates have remained stubbornly high for many, as cash-strapped banks continue to charge hefty premiums for lending money.
Offset makes more sense
Similar to making overpayments, an offset mortgage allows you to sit your savings alongside the money you owe on your house, thus reducing the amount that you pay interest on.
In the topsy-turvy environment we currently find ourselves, an offset mortgage can prove a savvy financial move: Why earn 2% on your savings when you are paying 4% interest on your mortgage?
Better still, your savings are protected from the tax man and can be accessed at any time.
So it’s hardly surprising that almost 1.9 million homeowners are considering offsetting savings against their mortgage, according to price comparison site uSwitch.
A practical example
Let’s assume you have the national average savings of £2,813 in your account, to which you plan to add £200 a month, taking your savings pot to £5,213 after one year.
In the average variable rate savings account at 1.26% AER, this would earn a total of £52 in interest during that time.
But offset this money against your mortgage for one year and you will save £221.17 - four times what you would earn in the savings account.
And the cumulative savings really add up over the years: On a 25 year £150,000 mortgage you will save a massive £40,000 and cut seven years off the term of your £150,000 mortgage, provided you set aside £200 every month.
Not difficult, just limited
Most people think you need a massive savings pot to benefit from offsetting, but uSwitch personal finance product manager Louise Bond says this simply isn’t the case.
“As long as you have a mortgage rate that is higher than your savings rate after tax, you will be ‘quids in’ by offsetting for as little as one year,” says Bond.
“In addition, you have the added security of being able to access the savings at any time unlike making overpayments."
Unfortunately, only 5% of mortgage deals currently allow consumers to offset, but Bond believes this will change if the demand for offsetting increased.
Offset not for everyone
An offset mortgage can prove particularly attractive for those who own a smaller chunk of their home, as lenders tend to impose far higher mortgage rates – anywhere up to 7% - on this group.
However, for those fortunate homeowners who locked into a tracker or variable rate mortgage before the base rate tumbled from 5% to 0.5%, your mortgage rate is already so low that an offset is unlikely to make sense.
Rather, you should look to pay off any other expensive debt you may have, such as credit cards or personal loans.
Or you can simply lock it in the best savings account you can find – ICICI currently pays a rate of 3.90% on its one year fixed rate bond.
