Offset mortgage

Ads

Offset mortgage

An offset mortgage is a type of mortgage common in the United Kingdom used for the purchase of domestic properties

The key feature of an offset mortgage is the ability to reduce the interest charged by offsetting a credit balance against the mortgage debt. For example, if the mortgage balance is £200,000 and the credit balance is £50,000, interest is only charged on the net balance of £150,000.

Lenders normally set a credit limit at outset of the mortgage and allow borrowers to credit and redraw up to this limit. This limit may be periodically reviewed. The lender may place restrictions on the lending limits towards the end of the mortgage term with the aim of ensuring capital repayment. However many lenders allow full drawdown up to the end date of the mortgage where the loan must be repaid. This can cause great problems for undisciplined borrowers and those approaching retirement if the lender is unwilling to extend the term (especially on the grounds of age).

Some lenders have a single account for all transactions, this is often referred to as a current account mortgage or CAM.

Other lenders have multiple accounts. As a minimum there is a mortgage account and a deposit account. Often the lender allows multiple accounts for credit balances and sometimes for debit balances. These different accounts allow the borrowers to notionally split their money according to purpose whilst all accounts are offset each day against the mortgage debt.

Partial reconfigurations of the offset mortgage are being introduced in the United States.

Tax Advantages

Within the UK offset mortgages are often marketed as offering 'tax efficient' savings. Interest generated within deposit accounts for UK residents is deemed income and is taxed at source (the rate has been 20% since 1983). Within an offset mortgage arrangement the notional 'credit' balance does not generate income but instead saves an amount of mortgage interest that would otherwise be charged. As no interest payment is made there is no tax charge.

Variants

Within the UK, many mortgage lenders offer offset mortgages. They fight for their share of the market by offering extra features or variants to the basic offset mortgage concept.

For example, some lenders have offset mortgages with an interest only payment schedule and full monthly interest offset. This means that the monthly interest payable is based on the balance on the mortgage account less the balances in the deposit and savings accounts. This results in lower sums of interest being paid by the borrower each month.

In another common variant, the borrower pays off capital and interest each month as if the mortgage account were a standard Repayment mortgage (i.e. as if the offset arrangement did not exist). However, the interest charged to the mortgage account is less due to the offset arrangement, than the borrower actually pays each month. This means that the borrower effectively overpays the mortgage each month and pays off the mortgage account earlier than planned.