Buy-to-let offset mortgages can be an effective way to get a rental property without bearing the burden of hefty repayments. But let’s first understand what is an offset mortgage?
An offset mortgage is a type of home loan where your savings are linked to your mortgage. The money in your savings account is ‘offset’ against your mortgage balance, so you only pay interest on the difference, potentially saving you a significant amount on interest payments.
But how is it different from a usual buy-to-let mortgage, and what are its qualification criteria?
Let’s find out.
Table of Contents
- How Does A Buy-To-Let Offset Mortgage Work?
- What Are The Advantages Of An Offset Buy-To-Let Mortgage?
- Types of Buy-To-Let Offset Mortgages
- How To Qualify For A Buy-To-Let Offset Mortgage
- What Are The Cons Of A Buy-To-Let Offset Mortgage?
How Does A Buy-To-Let Offset Mortgage Work?
A buy-to-let offset mortgage is attached to a savings account, the money from which can be used to reduce the mortgage amount for which you pay interest.
Once you get an offset buy-to-let mortgage, a savings account will be set up and connected to it. Any money deposited in the account will automatically be reduced from the mortgage amount.
However, keep in mind that you won’t earn any interest on your savings amount.
For example, if the buy-to-let mortgage amounts to £300,000 and you deposit £30,000 in the savings account, then you will pay interest on only £270,000. You’d still owe the full mortgage amount to the lender.
Although the lender typically provides this savings account, you can access its funds anytime for withdrawal. But in this case, the mortgage amount (and the resultant interest) will be re-adjusted automatically.
So, if you withdraw £10,000 from the account (in the above example), the interest will be calculated for £280,000 instead of £270,000.
But the term of repayment will depend on the type of mortgage arrangement you have.
While some arrangements may reduce the interest you pay, others may reduce the total term of the mortgage.
What Are The Advantages Of An Offset Buy-To-Let Mortgage?
As you may have already figured out, the numero uno benefit of offset buy-to-let mortgages is reduced payments, be it in the form of reduced interest or repayment term.
Besides, you will have the flexibility to choose between different repayment plans at your convenience.
We’ve seen that most lenders allow landlords to repay the mortgage at the pre-offset interest (calculated on the entire mortgage amount).
This means that you will pay more for each repayment without making arrangements for more cash every month, ultimately paying off the mortgage quicker than the decided term.
On the other hand, some lenders provide the facility of repaying the interest on the pre-offset amount. And with the offset applied to the principal amount, you can reduce your monthly repayments considerably.
In hindsight, the reduced repayment can help you budget your expenditures better, and you will always have access to the mortgage savings account for times of emergencies.
Aside from that, offsetting the buy-to-let mortgage will aid in more cash flow from the rental income, as you don’t have to give away a chunk of it for repayment.
Not only that, but you can also pool funds from your ISA (individual savings account) or current account for offsetting.
Hence, you don’t have to worry about getting emergency funds should you qualify for an offset buy-to-let mortgage.
Moreover, such an arrangement can prove to be tax-effective, especially for people who qualify for higher tax rates.
Types of Buy-To-Let Offset Mortgages
There are 4 types of offset buy-to-let mortgages in the UK, namely:
1. Fixed Buy-To-Let Offset Mortgage
A fixed buy-to-let offset mortgage works like a ‘usual’ fixed mortgage- once the principal amount is offset from the savings account, the interest rate on the remaining amount is fixed.
This option is typically offered for a mortgage term between 2 and 5 years, though some lenders may allow it for a longer mortgage term.
Since the repayment amount stays the same for the entire duration, it can be helpful for people who live on a tight budget (as they’d know the exact amount each month).
However, a fixed offset mortgage plan won’t allow you to reap the benefits if the interest rate on buy-to-let mortgages falls.
2. Variable Buy-To-Let Offset Mortgage
The interest rate (post offsetting the principal amount) in case of a variable buy-to-let offset mortgage will vary depending on different factors.
For instance, if you opt for a tracker mortgage, the interest rate will depend on an external factor (usually the Bank of England base rate). In other words, your interest rate will be directly affected by the fluctuations in the market.
Additionally, variable interest rates are applicable for discounted mortgages, in which the lender offers a discount on his standard variable rate (SVR) for a fixed time.
And although the interest rate always stays below the SVR, it can still vary, and so will your repayments.
3. Interest Only Buy-To-Let Offset Mortgage
For an interest-only buy-to-let offset mortgage, you will only repay the interest due (post-offsetting the principal amount) monthly or as the agreement decides.
You will still owe the full principal amount to the lender, which should be paid off at the end of the mortgage term.
As such, you should have a strong repayment plan in place to clear the mortgage at the end of the term- otherwise, you’d need to sell the rental property to pay off the principal amount.
Hence, this type of mortgage is considered high-risk but can be an easy solution if you do it right.
4. Family Buy-To-Let Offset Mortgage
A family buy-to-let offset mortgage can be the best way out if you want the benefits of an offset mortgage but don’t have the savings for it.
You can use your family savings (typically from your parents) to offset the principal amount of the mortgage. However, it’s not as common as the ones mentioned above.
How To Qualify For A Buy-To-Let Offset Mortgage
Given the nature of offset buy-to-let mortgages, it isn’t surprising that they aren’t as common as the usual buy-to-let mortgages.
But the interesting thing is they have similar criteria to the latter’s! For instance, many lenders require a deposit of at least 25% of the total mortgage value and a total rental income of a minimum of 125% of the repayment value.
Aside from that, your credit score, income, and age will be considered while deciding the interest rate. Note here that some lenders don’t process applications if you’re under 25 or over 75 years of age.
What Are The Cons Of A Buy-To-Let Offset Mortgage?
Although a buy-to-let offset mortgage may come across as an ‘easier’ way to buy a rental property, it’s not completely free from disadvantages, primarily high interest rates.
However, depending on how much one can deposit for offsetting, the problem can be countered significantly.
As such, this particular mortgage plan tends to be more beneficial for people with larger savings, as smaller amounts won’t provide them with the primary benefit of the arrangement.
Moreover, as we’ve stated before, withdrawing from the related savings account can increase your principal amount (and the interest).
Hence, many people prefer going for a regular buy-to-let mortgage with a regular deposit scheme, as a larger deposit can fetch lower interest rates. And considering the interest rate stays the same, the repayment may remain low.
However, the biggest problem with a buy-to-let offset mortgage is that it isn’t applicable to HMOs (houses in multiple occupations). In this case, you will have to apply for a ‘usual’ mortgage plan.
1. Can You Have Multiple Savings Account For Your Buy-To-Let Offset Mortgage?
Yes, it’s possible to link your mortgage to multiple savings accounts, especially for family buy-to-let offset mortgages. But this will completely depend on the terms and conditions of the lender.
2. Can You Offset 100% Of The Principal Amount?
Generally, there’s no limit on how much you can offset your principal amount, meaning you can offset 100% of the principal amount. You won’t be charged any interest in this case you will only be required to pay back the monthly mortgage amount.
3. What If Your Savings Account Has More Money Than The Principal Amount?
Having more money in the savings account will provide you with the benefit of 0 interest only- you won’t get any extra advantage out of the extra money.
Hence, it may be better to put that money in a regular savings account (to earn interest). Or use it to repay a larger chunk of the principal amount.
4. What Is The LTV Ratio Criterion For Getting A Mortgage?
The LTV (loan-to-value) ratio is a comparison between the principal amount of the mortgage and the perceived appraised value or selling price of the property. It’s calculated by dividing the former with the latter.
For example, if the mortgage amount is £200,000 for a property valued at £250,000, the LTV ratio is 80% or 0.8 (£200,000/£250,000). The higher the LTV ratio, the riskier the mortgage and the more the interest rate will be.
**A buy to let mortgage will be secured against your property.
Some types of buy to let mortgages are not regulated by the Financial Conduct Authority.