The great offset mortgage trick: How to beat savings rates stuck in the doldrums and get debt-free quicker. An offset mortgage delivers a tax-efficient savings trick that can boost the return on your cash and get you debt-free quicker. Clare Francis, editor of MoneySupermarket.com, crunches the numbers to explain exactly who can get the best most benefit.
Savers lose out to inflation and rates have fallen
The rate of inflation slowed slightly in August. The Consumer Prices Index fell from 2.6 per cent to 2.5 per cent. However, basic rate taxpayers still need to earn 3.13 per cent or more on their savings to beat tax and inflation, while those in the 40 per cent tax band need an account paying at least 4.17 per cent and 50 per cent taxpayers only generate a positive return if they’re earning 5 per or more on their savings.
With the rates on new savings accounts having fallen significantly over recent weeks this is getting harder to achieve and there are no accounts (apart from cash Isas) offering a positive return to 50 per cent taxpayers.
There is a calculator here that can help you to decide how it would work out for you.
The offset mortgage trick
One alternative for embattled savers is an offset mortgage. Offsets work by linking your savings to your mortgage.
Rather than earning interest – or paying tax – on your savings, your money is offset against your mortgage. As a result you pay less interest on that debt which, in turn means, you can clear your mortgage more quickly.
For example, if you had a £150,000 mortgage and £30,000 in savings, you would only be charged interest on £120,000. Your monthly repayments will probably be based on the full £150,000 meaning you effectively overpay each month and therefore pay your mortgage off more quickly.
Some lenders will allow you to reduce your mortgage payment to reflect the smaller debt, once your savings are take into account but this wipes out much of the benefit as you won’t pay the debt off any quicker.
With an offset you retain access to your savings so it is a much more flexible option than using your savings to pay off a chunk of your mortgage as you can get at your money whenever you want, in the same way you’d be able to if it was in a standard easy access savings account.
With many offset providers, you can also link your current account to your mortgage and in some instances your cash Isa enabling you to really maximise the benefit.
How is an offset mortgage tax-efficient?
With an offset mortgage you give up the opportunity to earn savings interest on the cash you put in, but the equivalent return you get in terms of shaving interest off your mortgage is tax-free.
That is because while most people pay tax on savings, unless they are held within an Isa, there is no tax to be paid on the gain that you achieve by reducing your mortgage interest. Tax on savings interest outside an Isa is paid at 20 per cent or 40 per cent, depending on whether you are a basic rate or higher rate taxpayer.