How to use your home to dodge the top rate of tax

By LAUREN THOMPSON
Updated: 20:17 EST, 24 August 2010

Top-rate tax payers are increasingly taking out offset mortgages to repay their home loans more quickly.

Offset deals allow borrowers to reduce the amount of interest they pay on their mortgages and so pay off the loan more quickly  -  but, in return, they must give up earning interest on the savings.

As most savers pay income tax on their savings, off-setting is increasingly attractive for those who pay 40 pc tax or the new 50 pc rate.

Our house: Off-setting is attractive for those who pay the higher rate of tax

The deals work by offsetting the amount of savings you have against what you owe on your mortgage, so you do not pay mortgage interest on the value of the savings.

Some lenders allow you to offset money in your savings, current account and Isa, and you retain easy access to all their money.

For example, a borrower has £20,000 of savings and an interestonly mortgage of £150,000.

Instead of paying interest of 5pc on £150,000 at £625 a month, they would pay interest on £130,000 at £542 a month basic rate. A saver would have to earn 6.2 pc before tax to match the savings and a higher rate taxpayer would have to earn 8.3pc before tax.

If the borrower has a repayment mortgage, the term of the mortgage could be significantly reduced because the monthly repayments will be overpaying the mortgage.

Most lenders allow customers on non-offset deals to overpay by only up to 10 pc a year before charging a penalty. And once you pay this off you can't usually borrow it back again  -  with an offset you can.

'Offset mortgages are attractive in this low-interest, high-inflation environment as it is so difficult to get a decent return on savings,' says David Hollingworth of broker London and Country .

'The big attraction is you can dip into your savings as necessary.'

With inflation at 4.8pc, basic rate taxpayers need to earn at least 6pc on a savings account to beat inflation.

But the average easy access account pays just 0.74 pc, according to comparison site Moneyfacts while the average standard variable mortgage rate is 4.73pc.

'Offsetting is tax-efficient, particularly for 50 per cent tax rate payers, because interest received on savings would normally be subject to income tax,' says Aaron Strutt of broker Trinity Financial Group. offset best buys include Yorkshire building society's two-year, fixedrate at 2.99 pc with a £995 fee for those with 25 pc equity; and First Direct's lifetime tracker at 1.99 pc over base, giving a current rate of 2.49 pc.

But ensure you know how an offset mortgage works. When you pay a lump sum into your offset account, Scottish Widows does not reduce your monthly payments.

Instead, you pay the same, but you will pay back more capital each month. Woolwich gives you the choice.