House Doctor: 'Should we use our savings for an offset mortgage when our fixed rate ends?'

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The Independent Online

Question: Our remortgage looms and with roughly £40,000 in our joint savings account, we wonder if an offset home loan might be best for us? Our current deal is a 4.2 per cent three-year fix that runs out in September. However, do we run the risk of higher repayments on a monthly basis? I understand that we offset our savings for less interest, but what about the dangers of a rising mortgage rate? Lisa White, Maidstone

Answer: Offset mortgages might sound like rather unappetising offshoots to a normal home loan but don't wrinkle your nose: they can offer wholesome financial benefits as long as you properly fit their criteria.

If you have substantial savings you can opt to save them with the same bank or building society with which you have your home loan. By then offsetting them against your mortgage, you only pay interest on the difference between the two. Imagine you have a £150,000 home loan and £40,000 savings: with an offset mortgage, you would only pay interest on £110,000. "On a 25-year loan at a typical offset rate of 3.75 per cent, this would save you £44,919 and enable you to clear the mortgage four years and 11 months early," says Melanie Bien at broker Private Finance.

With savings rates as low as they are, you'll save much more in mortgage interest than you could from a tax-free cash individual savings account, according to recent research from Defaqto analyst.

That's not all. Your offset savings are still accessible, so if you need to tap into them for an emergency there's no obstacle. There's also very little difference between offset mortgage rates and those for conventional mortgages. And if you want to take a repayment holiday – and underpay for a month or two, say – most offset loans will let you do this too.

These upsides have plenty of appeal, yet the downsides are considerable.

One, you'll save yourself thousands in mortgage payments but your actual savings won't earn a penny in the meantime. This is the de facto trade-off for a lower mortgage. Two, the flexibility of being able to still dip into savings if needed does mean you'll pay higher interest in the long term, since you'll be reducing your offset amount.

Third, offset mortgage rates are usually variable rate loans often pegged to the Bank of England base rate. While the interest rate climate is low, your monthly repayment will likely be easily affordable. But if rates rise sharply, will you be able to make the monthly payments?

If you prefer the stability of monthly payments, you could pick another fix but use chunks of your £40,000 to overpay.

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