Reduce Interest With An All-In-One Mortgage
Do you want to own your own home, but don't want to drain your entire savings to accomplish this? You may want to consider an all-in-one mortgage. This product allows you to combine your mortgage and savings. Let's take a look a look at how it works.
A British Immigrant
Until a few years ago, all-in-one loans were relatively uncommon in the U.S.; their predecessors have an established niche in Britain. The British version, which is called an offset mortgage, is slightly more straightforward; the mortgage is simply linked to a non-interest bearing account. The entire balance in the savings account is then applied against the loan balance. Therefore, if the borrower has a mortgage of $175,000 and savings of $35,000, the mortgage interest will only be calculated on the $140,000 difference. Because interest is calculated daily, the British borrower can withdraw from the account at any time, but in the meantime, the lender can use the deposit balance interest-free. Overall, the borrower also gets more of his or her monthly payment devoted to principal instead of interest. (To find out how to pay off your mortgage faster, read Be Mortgage-Free Faster.)
Not in America, You Won't
Unfortunately, because the IRS taxes interest paid and received differently than in Britain, American offset loans operate in a slightly different manner. The IRS will not allow taxable interest paid and received to cancel each other out as in Britain and Australia; each must be reported separately. Therefore, the "offset" loans available in the U.S. cannot technically be called by this name; in order for these loans to meet IRS guidelines, they must combine a checking account, home equity loan, and mortgage into one account. One account does not truly offset the other as it does in Britain. The single account offers all of the amenities of a normal bank account, such as an ATM and debit cards, automatic bill payments and a checkbook. But it allows every spare dollar the homeowner has to be used to pay down the mortgage until it is used.
This unique feature benefits the homeowner in several ways. First, because the homeowner's bank account is built directly into the mortgage, the homeowner will receive a much higher return on his or her deposits, because the money is being used to reduce the amount of interest assessed on the loan—which will almost always be at a much higher rate than what traditional demand deposit accounts can offer. Second, this type of account still offers instant liquidity in a way that traditional mortgages or even home equity lines of credit cannot. While some home equity lines of credit do offer access via checkbook or even debit card, they do not have the flexibility of this hybrid product. If the homeowner does not have the cash to make a payment on the loan in a given month, then no minimum payment is required because the minimum interest due is simply advanced from the available credit line. Finally, all-in-one loans are fully reversible; extra principal paid can be retrieved anytime, which solves a major problem inherent in trying to accelerate traditional "one way" mortgages, or even the offset loans available overseas. (To learn more about home equity loans, see The Home-Equity Loan: What It Is And How It Works.)
|Example - The Benefits of an Offset Mortgage
Dan needs a $400,000 mortgage at 6%. He has a net monthly income of $7,000. If he does a conventional 30-year fixed loan, his monthly payment will be $2,398. After all expenses, such as day-to-day living, the mortgage etc., he will be able to save $1,000 per month. But if he uses an "offset" mortgage, the $1,000 per month he saves will be used to reduce the mortgage balance for interest payment calculations as well.
Assuming that the rate on the accelerated loan stays constant at 6%, it is possible for Dan to pay off his loan in just under 15 years and still have the $1,000 he saved each month as well. It would not actually go into the mortgage; the lender would merely borrow it while the loan was being paid off to reduce the principal balance.
Perhaps most importantly, this type of mortgage can motivate borrowers to reduce their spending, because they can see their funds being used to pay down their loans.
Fees and Rates
Most offset mortgage lenders charge a $50 to $100 annual fee on top of other standard loan expenses, and higher rates usually apply for accelerated mortgages. Most accelerated loans are 30-year adjustable-rate vehicles that are tied to the LIBOR index. The adjustable rate for this type of loan could be 1% higher than conventional loans, unless the borrower opts to pay additional points upfront instead. But at the heart of the matter is the question of what is more important: rates and fees or the total amount of interest paid over the life of the loan? Obviously, a key issue to consider here is the lifespan of the loan. A slightly higher interest rate could be worthwhile if the loan is paid off several years sooner than a lower-rate loan. Remember that the time for repayment for an accelerated loan is not fixed; therefore, the borrower's projected surplus cash flow must be taken into account when making this comparison. (For more insight on payment structure, read Understanding The Mortgage Payment Structure.)
One of the main caveats of this type of loan is that most lenders who offer accelerated mortgages require borrowers to have FICO scores of at least 680 to 700 in order to qualify. This is because this type of mortgage will only benefit a borrower who has a consistent positive cash flow, with surplus funds available to reduce the principal of the loan on a regular basis. (To learn more, read Consumer Credit Report: What's On It.)
The Bottom Line
Although the benefits of this type of loan can be substantial, suitability is still a key concern, just as with any other loan product. Financially undisciplined borrowers may want to steer clear of taking one of these loans. Possessing too much available credit through the equity line aspect of the account could trigger spending sprees for some people, which will add to the debt's principal.
Another way to decrease mortgage-related debt is to secure a mortgage with a low interest rate. It's important to shop around as different lenders may offer different interest rates on the same type of mortgage and in the long-run securing a mortgage with a lower interest rate could save you thousands of dollars. A helpful tool that can assist with your with your research is a mortgage calculator like the one below.