The smartest mortgage for savers

Forget about savings accounts. If you want a proper return on your cash, your choice of mortgage is more important.

Who would be a saver? Bank base rate has languished at 0.5% for more than two years, and despite inflation still sitting comfortably above the Bank of England’s target, there’s still no sign of interest rates increasing any time soon.

Indeed, even though savings rates are now at their highest level in two years, the savings rates on offer are still pretty meagre. Finding a respectable return is very hard.

However, your choice of mortgage may provide the answer.

A substantial return with an offset

First Direct has done some research comparing the return on your money over the past two years, depending on whether you put that cash into a savings account or whether you used it in an offset mortgage.

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So why do offsets deliver such a substantial return? And why aren’t more of us using them?

How offset mortgages work

With offset mortgages, the name is a clue. You use your savings - which are always instantly accessible - to reduce the mortgage balance on which you have to pay interest. By doing so, you sacrifice earning interest on the savings, in exchange for saving money on the interest payments on your mortgage.

Let’s take an example. Say you have a mortgage of £200,000, over a 25-year term, with an interest rate of 4%. As things stand, your monthly repayments will be about £1,056.

Now let’s say you also have savings of £30,000 in the bank (lucky you!). With an offset mortgage, those savings are taken into account when working out how much of your mortgage you have to pay interest on. So in this example, you’ll only have to pay interest on £170,000 of your £200,000 mortgage debt. This means your repayments would fall to around £950 a month. Over a two-year period, that’s a saving – or return - of around £2,400, tax free. That's the equivalent of an annual return of 6.66% for higher rate taxpayers, or 5% for basic rate taxpayers, or an ISA at 4%. Try getting a return like that from an instant access account at the moment!

Saving money in the short and long term

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If you keep your repayments the same as they would be in a mainstream mortgage, then the whole debt is paid off far quicker, shaving years off the mortgage and saving thousands in interest payments in the process. So an offset mortgage can be used to save money on your mortgage on either the short or the long term!

Paying a premium

Unsurprisingly, you will have to pay in order to have the benefits of an offset mortgage available at your fingertips. And that means that the interest rate charged is often higher on offset mortgages than on mainstream mortgages.

For example, while the lowest rate on offer for a standard two-year tracker deal (for borrowers with a 35% deposit) is 1.99%. But if you want an offset mortgage, the lowest rate available is 2.29% (both mortgages are available from First Direct). Similarly, if you have a deposit of 30% and want a lifetime tracker mortgage, you will have to shell out 2.79% for an offset, compared to 2.47% with a normal mortgage.

This just demonstrates that if you’re going to go for an offset, you need to make the most of it. There’s no point paying a premium for an offset facility if you then don’t tie up a decent sum in savings alongside it.

Underestimating the benefits

That premium is one reason that many of us do not consider offset mortgages, but other borrowers are simply unclear on just how much they could benefit.

It has long been the perception that offset mortgages are the preserve of the rich – it’s only worth it if you have a vast amount of savings. But that’s really not the case. Even if you have a relatively small amount in savings, you can benefit, especially if you are in a higher rate tax bracket.

Besides, with bank base rate still at 0.5% after two years, and likely to stay there for another year, it’s unlikely that you will be able to get a decent return on your cash without locking it up for a number of years. With an offset mortgage, you can cut your mortgage outlay, and still have instant access to that cash! It’s the best of both worlds.

Perhaps you've saved heaps of money with an offset mortgage - or perhaps you think they are far too complicated to go for? Let us know about your thoughts and experiences using the comments box below!

15 outstanding offsets

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At lovemoney.com, you can research all the best deals yourself using our online mortgage service, or speak directly to a whole-of-market, fee-free lovemoney.com broker. Call 0800 804 8045 or email mortgages@lovemoney.com for more help.

This article aims to give information, not advice. Always do your own research and/or seek out advice from an FSA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article. 

Finally, we tend to only give the initial rate of a deal in our articles, but any deal which lasts for a shorter period than your mortgage term may revert to the lender's standard variable rate or a tracker rate when the deal ends. Before you take out a deal, you should always try to find out from your lender what its standard variable rate is and how it will be determined in the future. Make sure you take all this information into account when comparing different deals.

Your home or property may be repossessed if you do not keep up repayments on your mortgage.