This clever mortgage will save you thousands

An offset mortgage can help you to kill off your home loan in record time.

Very few homebuyers have considered using an offset mortgage, according to new research from Yorkshire Building Society.

In February, Yorkshire interviewed 2,000 adults in order to discover what they knew about offset loans -- those most modern of mortgages.

What the mutual found was that hardly any borrowers understand offset mortgages and how they work.

This research found that only one in 14 homebuyers (7%) have considered an offset mortgage when buying a home. What's more, two in five borrowers with substantial savings -- the people likely to do well through offset mortgages -- were not given this option when looking into home loans.

What's more, 30% of adults questioned didn't know that offset mortgages even exist, a third (33%) had no idea how they work, and the remaining 36% didn't fully understand them.

John Fitzsimons explains why the best mortgages offer you a bit of flexibility

Thus, according to YBS, up to 10 million homeowners may be missing out on making their most of their savings.

How offsets work

Today, we at lovemoney.com aim to put things right, with a simple guide to making the most of these modern mortgages. Here's our easy-to-understand guide to offset mortgages:

1. Come together

Offset mortgages have been around since 1994, when they were introduced into the UK from Australia -- one country where folk refuse to put up with rip-offs.

In a nutshell, an offset mortgage combines your mortgage, savings (and even your current account) under one roof. By doing so, it enables you to reduce the amount of interest you pay, potentially saving you thousands of pounds over the life of your home loan.

Let's say that you have a mortgage of £120,000, plus £20,000 in a separate savings account. By combining the two in an offset account, you pay interest only on your 'net debt' which, in this case is £100,000 (£120,000 minus £20,000).

In effect, your savings 'offset' some of your loan and 'earn' tax-free interest at the offset mortgage rate. However, you still have easy access to this spare cash at any time. Given that mortgage interest rates are usually higher than savings interest rates, switching to an offset can leave you quids in.

2. Flexible, faster paying off

Another attractive feature of offset mortgages is their flexibility. With these loans, forget about fixed monthly payments. Instead, you can overpay, underpay and take payment holidays to suit your needs.

What's more, by overpaying, you cut your current and future interest bill. This enables you to clear your mortgage debt faster and shorten the life of your loan, perhaps by several years. Indeed, overpaying regularly and adding occasional lump sums to your savings offset can save you thousands of pounds.

3. Getting cheaper all the time

When offset mortgages were in their infancy in the Nineties and early Noughties, they were a lot more expensive than traditional mortgages. In fact, choosing to offset could mean paying an extra 1.5% on your yearly interest rate.

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However, increased market competition has brought down the interest rates charged by offset mortgages. For its offset option, Yorkshire BS adds just 0.1% to the interest rates charged on its bog-standard mortgages. With some lenders, offsetting is available at no extra cost, making it a valuable freebie.

Six mortgage myths

As public understanding of offset mortgages is so low, I'm going to dismiss six 'offset myths':

Myth one: you need a large savings pot to make offsetting worthwhile. Not so! According to Yorkshire, savings of just £2,500 could clip seven months from the life of a 25-year, £100,000 mortgage, while reducing the interest paid by a tidy £4,142.

Myth two: only big overpayments are worthwhile. Nope -- paying an extra £25 a month could slice nine months from the above mortgage, saving you £4,908 in interest.

Myth three: you can't separate your savings from your mortgage. Oh yes, you can; your mortgage and savings are held separately. They are combined only to calculate how much interest you owe on the difference between them.

Myth four: offset mortgages cost more than traditional mortgages. Sure, this used to be the case, but no longer. These days, many mortgage lenders provide free offset facilities.

Myth five: your savings are 'trapped' with an offset. No, you retain instant access to your savings at all times, just as you do with an easy-access savings account.

Myth six: offset mortgages are too complicated and difficult to understand. I disagree; all they do is use your savings to reduce your mortgage interest bill.

Best buy offset mortgages

Here are five table-topping offset mortgages available today:

(Based on a £100,000 interest-only mortgage over 25 years, used to buy a £180,000 property)

*Lender*	*Rate* *type*	*Rate*	*Monthly* *repayment*	*Discount* *period*	*Fees* *payable*	*Max* LTV*
first direct	Tracker	2.29%	£190.83	2 years	£2,997	65%
Yorkshire BS	Tracker	2.39%	£199.17	To 30/04/13	£1,995	75%
Accord Mortgages	Tracker	2.49%	£207.50	To 31/05/13	£1,995	75%
Clydesdale Bank	Discount	2.59%	£215.83	To 30/06/13	£999	65%
first direct	Tracker	2.59%	£215.83	2 years	£597	65%

Source: lovemoney.com's mortgage service

* Maximum loan-to-value (maximum loan as a percentage of the purchase price)

Now is the perfect time to offset

With the Bank of England's base rate stuck at a record low of 0.5% a year since March 2009, savings rates are truly terrible. Sadly, with inflation -- the rising cost of living -- currently running at 4.4%, almost all savings balances are shrinking in real (after-inflation) terms.

Therefore, by switching to an offset mortgage, you can 'earn' a tax-free rate of interest equal to your new mortgage rate. In effect, you earn a higher rate of interest on your spare cash, while dodging tax and keeping easy access to your money.

If you'd like to find out how much offsetting could save you, then try our no-obligation mortgage service. You may be pleasantly surprised at how you could save in the years ahead!

More: Find your perfect mortgage | The cheapest street to buy a home | Avoid rising mortgage fees

Use lovemoney.com's innovative new mortgage tool now to find the best mortgage for you online.

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 freephone 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.