On balance, is an offset a good deal?

Offset mortgages look like the perfect way to pay off your home loan faster. They work by setting your savings and income against your loan, so the amount of interest you need to pay is reduced, which means you can clear your capital more quickly. But, until recently, the higher rate of interest charged for these mortgages had made them less beneficial than they appeared. That difference is starting to disappear rapidly and for some larger borrowers has now disappeared altogether.

Intelligent Finance (IF), a leading offset provider, announced special two-year tracker loans - available through brokers such as John Charcol and London and Country - that match or even beat some of the lowest rates on traditional tracker loans without offset facilities. But there are catches: the loan has to be over £200,000 and there are large arrangement fees of £1,499-£2,499, depending on the broker. On ordinary trackers, these fees are typically £500-£700.

If you don't have to pay a higher rate of interest it is easy to see how an offset mortgage could be advantageous, especially if you had substantial savings. These savings are set against your loan so you wouldn't pay interest on that part of your debt. This means if your loan is £200,000 and you have £50,000 in savings, you will be charged interest on only £150,000. But your monthly repayments would still be calculated on the £200,000 loan, so you would be paying off more capital each month, thereby reducing your loan more quickly.

Ray Boulger, senior technical manager at John Charcol, says the reason for the high minimum loan is that large loans are more profitable, so lenders can make their terms more attractive.

'The more of these deals there are and the more lenders that come into the market, the more competition there will be and the lower the differential for offset will get,' he says. 'This has already happened to a certain extent and I think we are a long way down the road to the differential disappearing altogether.'

He says IF's current deal is likely to be most cost effective for people with loans of at least £250,000. 'They don't need to have a large amount of savings to benefit from offsetting. The ideal person is someone with a volatile income, such as someone who gets large bonuses or overtime payments, or is self-employed and gets large sporadic payments.'

So who else could benefit from an offset mortgage? IF says about one in three people looking for a mortgage could be better off with an offset, providing they have savings of at least 8 per cent of their loan to offset their mortgage. By offsetting, say £8,000 in savings against a £100,000 loan, IF says they could cut their mortgage term by five years and save £39,091 in interest. But smaller offset loans typically cost more.

David Hollingworth, of mortgage brokers London and Country, is a supporter of offset mortgages in the right circumstances but says IF's calculations can be misleading. He says: 'My gripe is that they assume you will still be paying the same mortgage rate if you don't offset whereas in actual fact you could probably get a more competitive deal elsewhere and pay say 0.5 per cent less.'

Paying a lower rate of interest can also help you clear your mortgage quicker. He calculates that if you had a £100,000 mortgage without offsetting costing, say, 4.5 per cent, but made overpayments equivalent to 5 per cent each month, you could save £15,000 and pay off your loan two years early. Using your £8,000 savings to actually reduce the size of your mortgage would speed things up more.

Before taking out an offset mortgage, borrowers should consider both their financial position and what they really want from their mortgage. Boulger says: 'If you have a stable income, most of which you spend each month, and only a small amount of savings, the benefit of an offset mortgage is very small.' Hollingworth adds: 'If all you want to do is overpay your mortgage, there are loads of deals that will allow you to overpay by up to 10 per cent a year without penalty.'

Offset mortgages are attractive for people who want to be able to get to their savings. There is the incentive that by offsetting they are getting a return which is not taxable because they are not earning interest. To equal a 5 per cent mortgage rate, for example, a basic rate taxpayer would have to earn gross interest of 6.4 per cent while the gross rate for higher-rate taxpayers would be 8.3 per cent.