A Complete Guide to Offset Mortgages

What Is an Offset Mortgage?

An offset mortgage links your mortgage borrowing to a separate savings (and sometimes current) account.

The lender charges interest on the net balance — so if you owe £250,000 but hold £75,000 in the linked account, interest is only charged on £175,000.

These linked funds remain accessible, unlike conventional overpayments. But they don’t reduce your actual loan capital — they simply reduce the interest charged.

So think of an offset account like making an overpayment you can easily reverse.

How Offset Mortgages Work: Payment Reduction vs Overpayment Models

Offset products typically offer two configurations:

1. Monthly Payment Reduction

The offset balance lowers the interest charge, resulting in reduced monthly payments. Capital repayment continues as usual unless otherwise structured. Useful for borrowers seeking lower monthly payments or cash flow headroom.

2. Term Reduction (Overpayment Effect)

Monthly payments remain calculated on the full mortgage amount, but more of each payment goes towards capital — shortening the mortgage term. This is typically more efficient if your goal is to reduce total interest paid and clear the mortgage early. Some lenders allow borrowers to switch between these modes during the term, but it varies by product.

Interest Rate Spread: Why You Need Meaningful Savings to Break Even

Offset mortgages almost always come at a premium compared to equivalent non-offset products. A spread of 0.3–0.75 percentage points is common.

This means you need to maintain a substantial and consistent offset balance for the offset to be economically worthwhile. For example:

• If a 5-year fixed offset mortgage is priced at 5.25%, but a comparable standard mortgage is available at 4.50%, you’d need to hold around 15% of your overall mortgage balance in the offset account, just to break even.

Calculating this exactly gets messy as you also need to consider the interest you would otherwise earn on that money too, and your tax rate. But as a simplified general rule, divide the lower rate by the higher to get a rough percentage of equity that needs to be held at all times.

This dynamic makes offset products largely unsuitable for borrowers without long-term liquidity or those who tend to draw down savings regularly.

It’s therefore really important to take good advice to ensure an offset is right for you, so always discuss with a broker.

Strategic Uses of Offset Mortgages

Offset mortgages can enable financial strategies that are either impossible or riskier with conventional products.

1. Inheritance or One-Off Lump Sums

A borrower who expects a large future overpayment — for example due to inheritance — but wants fixed-rate security in the meantime may struggle with standard mortgage overpayment limits (typically capped at 10% annually, occasionally 20%).

With an offset, the full amount can sit in the linked account immediately, reducing interest from day one without triggering early repayment charges. However, this only makes sense when:

• The anticipated lump sum is large (e.g., >25–30% of the loan).
• The product spread is not excessive.
• The funds are genuinely available long-term (not re-spent).

2. Raising Capital Now for Future Extensions or Buy-to-Let Investments

Some borrowers use offset products to raise funds now for later use. For example:

• Including the costs of a planned extension whilst remortgaging or buying a home but only paying for the funds as they are spent.
• Raising a “war chest” for buy-to-let investments against your main residence and turning yourself into a cash buyer, but only paying on drawdown.

This avoids future affordability reassessments and can lock a fixed rate across the full borrowing — useful where income volatility, regulatory tightening, or interest rate changes might otherwise make remortgaging difficult later.

With any planned use of an offset account its important to get advice on whether it’s suitable for that purpose and to consider other tax and legal implications.

Tax Benefits for Higher Rate Taxpayers

One often-overlooked feature of offset mortgages is their tax efficiency.

• Savings in the offset account don’t earn interest — instead, they reduce interest charged on the mortgage.
• This means there’s no taxable income to declare, even though you're gaining an effective return equal to the mortgage rate.

For higher and additional rate taxpayers, this can outperform conventional savings as per the following hypothetical example:

A mortgage rate of 5%, is equivalent to 8.33% gross at 40% tax rate, and 9.09% gross at 45% tax rate.

Compared to typical savings rates, this is highly efficient — especially now that the Personal Savings Allowance (£500 for higher-rate taxpayers, £0 for additional rate) is often quickly used.

But you also need to factor in the cost of the interest rate spread described above (on the net remaining mortgage balance) and deduct this from the apparent savings of the offset in your comparison to alternative savings or investments.