Offset mortgages; how they can shave thousands off your debt

If you have built a significant savings pot, then choosing an offset mortgage enables you to make further savings by shaving years off your mortgage term and reducing interest payments.

In fact it's been calculated, by crunching various market statistics, that the average British homeowner could save almost £70,000 in interest and knock seven and a half years off the term with an offset mortgage.

And now could be the time to take advantage of one of these loans. According to the Financial Services Authority an estimated 1.4 million homeowners will see their mortgage repayments rise by an average of £210 a month because their short term fixed-rate home loans are due to mature in the next 12 months.

Are you looking for an offset mortgage? Moneyextra Mortgages can help

Some people, especially those looking for a high LTV (percentage of loan to value), are likely to find it harder to remortgage at a competitive interest rate.

The high LTV can be reduced by utilising savings to make a one-off or regular lump sum overpayments on your mortgage, provided the lender allows and penalties are not incurred. A £100,000 repayment mortgage over 25 years at a fixed 6% incurs almost £93,300 in interest over the loan's life. Overpay the £644 monthly repayment by £100 a month and the overall interest paid is cut back to some £66,200 and the mortgage term reduced to just over 18 1/2 years.

Savings are set against debt

An offset mortgage is basically a sophisticated variant of overpayment but a certain element of discipline is required of the borrower to make it worthwhile. In essence you set up a savings or current account (or both) with your mortgage lender; money in the account is set against the mortgage debt to provide a daily interest calculation. So, for example, a £200,000 mortgage and £20,000 in a linked savings account means that interest is paid only on the net balance of £180,000.

This has the same effect as making a £20,000 mortgage overpayment with the difference that the savings are still accessible should they be needed for some financial emergency. Offset mortgages also allow unlimited overpayments in the real sense so borrowers can further reduce total interest payable and shorten the term of the loan.

Growing number of providers

The concept of allowing borrowers to offset savings against mortgage debt first appeared on the UK market in 1997 in the guise of current account mortgages.

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The idea of offsetting was born in Australia; it is now estimated that approximately 50% of all mortgages taken out in that country have some form of offsetting element built in. Over here take-up has not been so spectacular. Ten years ago appeal was limited but product innovation and an increase in supply of offset mortgages have since helped the pricing of such loans to become more competitive. There are now 30 providers and around 250 products in the UK.

07 February 2008 © Moneyextra.com

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