Why An Offset Mortgage could beat an ISA for Savings

By: Katie Jenkins
07-May-2010

Research by HSBC-owned lender first direct has found that savers who kept their funds in ISAs for the past ten years may actually have been better off using those savings to bring down the interest rate on their mortgage.   The study calculated the largest possible saving that you would have enjoyed from using up your ISA allowance each year since the start of the 2000 tax year on April 6th, working out to 38,328 GBP.  

If you had instead put the same amount of money into an offset mortgage account, thus making the equivalent savings on your interest rate as well, you would have saved a total of 31,200 GBP but also have knocked up to 10,434 GBP off your mortgage repayments too.  This equates to a total saving of 41,634, or 3,306 more than your ISA would have earned for you.

What exactly is an Offset Mortgage?

An offset mortgage works by reducing the balance of your mortgage by the amount of money you have saved in a separate, but linked, savings account. Instead of earning interest on the money on your savings, you'll have this amount effectively deducted from your mortgage balance, meaning that you only have to pay interest on the remainder.  For example, if you had a mortgage of 100,000 GBP and savings of 15,000 GBP in an offset mortgage savings account, you would only pay mortgage interest on 85,000 GBP of your mortgage.

The main benefits of this product are that you don't pay any tax on savings you would otherwise have earned, and that you can pay off your mortgage loan faster.   As you'd expect, offset mortgage deals vary between lenders, with some lenders enabling you to link your mortgage to a current account instead a savings account.  The current account mortgage (CAM) was the original type of offset mortgage available in the UK, but back then, you'd have to have lumped together your mortgage and account balance, whereas now you can keep them separate.

So does the same apply to saving in the 'tennies'?  

Due to the low interest rates, savers do not currently have a lot to get excited about, despite the recent increase in the ISA allowance from 7,200 GBP to 10,200 GBP.  Therefore, it's worth considering an offset mortgage if you are in a position to move from your existing mortgage deal, or if you are taking out a mortgage for the first time and you have savings that you would like to use against your loan.  

A Flexible Saving Option

In addition to being able to pay down an immediate debt, you will usually find that savings accounts linked to an offset mortgage will allow you instant access to your money.  In a standard savings account, the rule of thumb states that the longer you're prepared to lock your money away for, the higher the interest rate you'll receive.

Richard Tolchard, senior mortgage product manager at first direct, commented: "For people without a mortgage or possibly nearing the end of their mortgage, cash ISAs are often the most efficient way to save cash. However for savers who hold a mortgage, this analysis show that cash savings work harder offsetting against a mortgage than they do within a tax efficient ISA."