Offset mortgages are set to become hugely popular, especially amongst higher tax payers. How do they work, what’s the benefit and is there a catch? This article investigates.

• Offset mortgages represent one of the biggest mortgage innovations seen in recent years
• Six years ago there was hardly an offset mortgage to be seen
• Now they and the current account mortgage, to which they are closely related, account for £10 out of every £100 of new lending.

What’s more, one of the UK’s large lenders believes that 25% of existing mortgage holders would be better off with an offset mortgage. So if you’re in the market for a mortgage you need to know what they’re all about. Otherwise you could be missing out.

Firstly, how does an offset mortgage work?

The basic idea is that besides borrowing money from the mortgage lender, you also run savings or deposit accounts with them. Then you are charged interest not simply on what you have borrowed but on what you have borrowed _less_ the balance in your savings and deposit accounts. So, if you had an offset mortgage of £100,000 and had £20,000 in their savings account you would only be charged interest on the difference, £80,000. In these circumstances, no interest is paid on your savings – the interest is offset.

It doesn’t sound like a ground breaking idea - where’s the benefit?

Quite simple. Whilst the full benefit of your savings is reflected in a lower interest charge on your mortgage account, legally you have not received any interest. If you have not received interest you can’t be charged tax on the interest. Step away Mr Taxman! This means that offset mortgages are especially attractive for higher rate taxpayers who would otherwise pay-away 40% of the interest they receive in tax. Consider some figures -

• If you had a £100,000 mortgage paying a competitive rate of 4.69% plus £20,000 on deposit, how would the figures work out?
• Well over a typical 25 year mortgage, without offset you would pay £85,351 in interest but with offset you would pay just £41,998 – that’s a saving of £43,353
• What’s more you would repay the mortgage five years and eight months early
• That’s because the monthly repayments are based on the full mortgage debt before offsetting is taken into account so borrowers are effectively overpaying their debt each month

And doesn’t Mr Taxman look sorry! In theory, a standard tax payer saved £9,538 in tax and a higher rate taxpayer a whopping £17,341 in tax.