Offset Mortgages

With a traditional mortgage, you borrow a set amount over a set term and make regular repayments until the debt is cleared. Then came flexible mortgages, which allowed you some measure of freedom in your repayments, making higher payments to reduce your debt if you had some spare cash, or taking a 'payment holiday' if money was tight.

The ultimate flexible mortgage is an offset mortgage, which is a relative newcomer to the UK market.

How they work

An offset mortgage basically combines your mortgage, savings, current account, and other borrowing such as loans into one huge, flexible account. It can help to think of an offset account as being similar to a normal bank account with a huge overdraft limit.

Your mortgage repayments go towards reducing the balance of your 'overdraft', much like a traditional mortgage.

The crucial difference is that any savings you have, and any credit in your current account, is used to reduce your debt temporarily in a process known as offsetting, while any borrowing set against your mortgage increases your overall balance.

Offsetting example:

Say you had a mortgage balance of £100,000, savings of £10,000, and a regular income of £2,500 a month. Your savings would be offset against your mortgage, effectively giving you a balance of £90,000. At the start of the month, your £2,500 income would also be set against your mortgage, giving you an effective balance of £87,500.

This lower effective balance reduces the amount of interest you pay, meaning you can either make lower repayments to clear your debt more quickly.

It's important to bear in mind that you can still access your savings and current account as normal, with any withdrawals simply increasing your effective balance as less is used in offsetting.

The benefits

An offset mortgage will let you use any savings you have to reduce interest charges, meaning you can clear your mortgage more quickly, while still having full access to your funds.

As mortgages charge a higher rate of interest than that earned in most 'safe' investments, using your savings to offset mortgage costs gives you a better return for your money.

Most offset mortgages also feature a high degree of flexibility, meaning that you can vary you payments as circumstances require you to, with the only penalty being increased interest payments if you slow down your repayments.

The drawbacks

The great flexibility of an offset package can also be a drawback. The temptation can be to repay less than you'd need to to clear your debt over the standard 25 year term, meaning you could be left with a balance to make up. If you're disciplined and keep an eye on your repayment rates then this shouldn't become an issue.

Where can I get an offset mortgage?

Most major banks will offer some form of offset mortgage these days, although the pioneers are the direct banking offerings of The One Account (administered by RBS) and Intelligent Finance, part of the Halifax Bank of Scotland group.