Is an offset mortgage right for you?

Q: I've been reading up on offset mortgages and to be honest they seem too good to be true. What are the drawbacks of such a mortgage? I found one with First Direct with a fixed-interest rate at 3.99%, which is not too bad. Also, say I took out a £100,000 mortgage, what is the maximum amount of savings I can offset it against?

A: Richard Morea is technical manager at London and Country

Offset mortgages have grown in popularity since their introduction in the 1990s and are now an established option within the mortgage market.

With an offset mortgage, the lender charges interest on the difference between the mortgage balance and any savings held with the lender.

This means that a borrower with a £150,000 mortgage and £30,000 in savings will only be charged interest on £120,000 of their mortgage.

The trade off is that the lender does not pay interest on the savings, but considering tax is due on interest paid on savings accounts (unless you have an individual savings account), the rate saved on the mortgage account, can often be greater than the net return that could be achieved on any savings.

Lenders generally allow the borrower to offset up to 100% of the mortgage costs, which essentially provides interest-free borrowing.

Where the interest is reduced through offsetting, the borrower usually continues to make the full monthly repayment, which reduces the capital balance.

When considering an offset mortgage, the key is to not be swayed by features such as unlimited overpayments, underpayments and payment holidays, especially if it's unlikely you will use them.

Any mortgage should be compared on the key elements such as the interest rate and any fees, remembering to include traditional mortgages that may be more suitable.

Offset mortgages can come with higher interest rates than might be available for traditional mortgages, so the borrower has to be certain they will benefit from an offset deal if they are to pay a premium.

However, the margins have reduced and in some cases offset deals have market leading rates, especially on lifetime trackers where they are most common.

Some lenders allow the borrower to also offset their current account, so it may be worth considering switching your banking, especially as you are considering a deal with First Direct.

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Your Comments

It'd be nice to know who offers offset mortgages at the moment, and who offers offset-like mortgages which allow you to overpay and also to withdraw your overpayments should you need them.

A nice table comparing their features (interest rate, term, fees, early repayment conditions etc.) would be good too!

I managed to bring my savings into balance with the mortgage, and so paid no interest.

The interesting part was that, had I ended the mortgage, 'early repayment penalties' would have applied. On enquiring with the lender they stated that 'until the borrower informs the lender that they wish to end the mortgage, the debt continues to be outstanding.' 

That said, they also confirmed that many borrowers incur those penalties purely because they don't ask, and terminate the contract!

I did terminate early, but only after the penalties expired. My reasoning was that should the bank/building society go broke my savings would disappear (notwithstanding government guaranteed limits) but the debt would remain outstanding.