DEFINITION of 'Offset Mortgage'

A type of mortgage that involves blending a traditional mortgage with one or more deposit accounts; the savings balance(s) held in the latter can be used to offset the mortgage balance. Both the account and the loan are held at the same banking institution, and an initial loan balance (or credit limit) is established, along with an interest rate. The savings account is typically a non-interest bearing account, allowing the bank to earn a positive return on any balances in the account.

When each mortgage payment is made, the interest is calculated on the principal remaining in the mortgage account, minus the aggregate amount of savings in the one or more deposit accounts. Borrowers still have access to their savings; if money is removed from savings during the month, the next mortgage payment will be calculated on a higher principal balance.

For example, if the mortgage principal is $225,000 and $15,000 was held in savings during the last month, the interest due would only be calculated on ($225 – $15) = $210,000.

BREAKING DOWN 'Offset Mortgage'

This is a very attractive option for people that can be diligent savers - even though the savings account won't earn any interest, they are typically low-earning accounts that only pay 1-3% per year. Chances are that the interest rate on the mortgage is substantially higher, so any savings there is a net benefit to the borrower. Meanwhile, the foregone interest on the savings account becomes non-taxable payments towards the mortgage.

Offset mortgages are common in many foreign nations, such as the U.K., but are currently not eligible for use in the U.S. because of tax laws.

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