An offset mortgage is actually a combination of a saving deposit account and a traditional mortgage. Offset mortgages can benefit borrowers who are adept at saving money.
The deposit account and the mortgage are held at the same lender institution, and the deposit account usually doesn’t return interest to the borrower. Each time a mortgage payment is made, the interest the borrower pays is calculated on the remaining loan balance.
However, the interest is offset by the total amount of money the borrower has in her deposit account at the time. She can still take money out of the deposit account, but if she does so, her loan payment will go up the next month. For example, if a borrower has a loan with a £175,000 principal balance but has £75,000 in the deposit account, she’ll only be charged interest on £100,000.
For comparison, if she has a £175,000 balance but took £15,000 out of her £75,000 deposit account savings, she’ll pay interest on (£175,000 –£60,000) = £115,000.
Offset mortgages reduce a loan term and the overall cost of the home loan to borrowers who save well. A borrower may chose to reduce monthly payments immediately or shorten the loan term; mortgage interest saved reduces the principal balance. The money in the deposit account is not subject to taxes because the borrower isn’t receiving any interest, and this is a benefit to a borrower who pays a higher rate of taxes.
The borrower also still has access to her saving in the event of an emergency, but taking money out of the account increases the loan term and the total interest she’ll pay. Even small savings reduce interest; most lenders calculate the interest rates on a daily basis. An offset mortgage may have an overpay limit; the limit caps the savings deposit total at a certain amount.