Ever wished your mortgage rate was the same as your savings rate, or vice versa?

It can be, if you switch to an offset!

If you've got savings at the moment, chances are they're earning a dismal rate - maybe three per cent if you're lucky. Then there's tax deducted on that.

How would you prefer it if you could really put that money to work, earning you the equivalent of around six per cent interest, and letting you pay off your mortgage four or five years early?

Following last week's article on saving our savers, we've been looking at offset mortgages and wondered whether enough savers know there's a way of getting the best of both worlds.

Offsetting: the basics

If you're a saver, you earn interest. If you're a homeowner with a mortgage, you pay out interest. So you need to get these interest rates balanced out to work in your favour.

Unfortunately, that's hard to do with separate accounts.  Base rates mean savings returns are low, but mortgages are cheap. The cost of borrowing is a bigger drain on your finances than any boost you'll get from saving.

Offset mortgages let you combine the two balances and even out the two rates. If your mortgage is more than your savings, you only pay interest on the difference between the two. (Read our offset mortgages guide for an illustration).

How to understand offset rates

Look at it as a savings rate on steroids. Or a mortgage rate on a diet!

Let's take Woolwich's 3.49% tracker offset mortgage as our example. Your savings and mortgage are still in separate 'pots', so you can still keep track of your balances separately (and dip into your savings at any time). However, there are three crucial differences to having separate accounts:

• Your mortgage interest is calculated daily, so every pound is working for you all the time.
• because you don't "earn" the interest as credit interest, you aren't taxed on it.
• thanks to the compound effect (i.e. interest on interest), it's a dramatic difference to savings which only pay out yearly.

For example, one lender is offering an offset mortgage that combines your current account, savings and mortgage balances to reduce the interest you pay.  The rate is around 3.5 percent, a nice low one for mortgages but a great one for savings.

So you can consider it as a mortgage rate in the usual way – but you could also consider it a tax-free, compounded savings rate!

Tax-free? How?

When you're earning interest, typically it gets treated like any other earnings: taxed at 20%, or 40% for higher-rate taxpayers (unless your savings account is part of an ISA). So you end up with less than the advertised rate. A problem.

When you've got your savings being set off against your mortgage, you don't earn the interest: instead you have it reduce what you pay. This means nothing is taxable. Problem solved!

You never actually see interest accruing on your savings, so you might say that's less rewarding. But you also don't see the interest on your full mortgage being added to your mortgage account - so you do see what you owe going down a lot faster. That's motivational.

Years off your mortgage: an illustration…

For as long as your mortgage balance is greater than your savings, you are accelerating the rate at which you're repaying your mortgage. Done properly, offsetting could give you a few extra years of mortgage freedom, without an extra pain now.

Curious about how a regular customer could benefit, I asked one mortgage company for a forecast.  I found out that…

• with £80,000 mortgage balance on a £120,000 house
• with £10,000 in savings and £100 being saved each month
• with a 'best alternative' of 2% on savings available elsewhere
• with a 20% tax rate and an average current account balance of £1,000

...I could pay off my mortgage four years and three months early.

That's four years of financial freedom I'm sure I'll appreciate when retirement is looming.

Who could benefit from offsetting mortgages and savings?

If you are any of the following:

• you have savings over £5,000
• you're a higher rate taxpayer
• you save regularly for your annual tax bill
• you often have excess funds left in your current account
• you already have savings earning less than 4 per cent
• you're worried you'll still be repaying your mortgage in retirement

...you could benefit from mortgage advice from an FSA-authorised independent adviser about offset mortgages.

- compare tracker mortgages

- compare discount mortgages

- compare fixed rate mortgages

Share your views

We think offset mortgages are a clever way to pay off your mortgage early without putting yourself under financial pressure.  However, if you have a view on the matter, or experience of this area, do share your thoughts in the comments below...