What is an Offset Mortgage?
An offset mortgage is a type of mortgage that involves blending a traditional mortgage with one or more deposit accounts held by the same financial institution. The savings balance maintained in an account may offset the mortgage balance.
The financial institution establishes an initial loan or credit limit, along with an interest rate, for any borrowed funds. The savings account is typically a non-interest bearing account, which allows the bank to earn a positive return on any balances held in the account.
Offset mortgages are standard in many nations, such as the U.K., but are currently not eligible for use in the U.S. due to tax laws.
Understanding Offset Mortgages
An offset mortgage is a desirable option for people who are diligent savers. The linked savings account will not earn interest during the life of the loan. However, most savings accounts are typically low-earning accounts which pay only 1% to 3% per year.
- An offset mortgage involves blending a traditional mortgage with one or more deposit accounts at the same financial institution.
- The savings balance maintained in the deposit accounts may offset the mortgage balance.
- Offset mortgages are standard in many nations but U.S. tax laws do not currently allow them.
- An offset mortgage is an attractive option for paying back a mortgage loan primarily because the borrower can make small payments to pay down the principal instead of the interest.
The mortgage interest rate is substantially higher than the rate paid on the savings account, so any savings there is a net benefit to the borrower. Also, the foregone interest on the savings account becomes non-taxable payments towards the mortgage.
The calculation of interest is on the remaining balance of the note less the aggregate amount of savings in the one or more deposit accounts. The borrower still has access to their savings account. However, the next mortgage payment will be calculated on a higher principal balance if the borrower withdraws funds from the account.
More than one savings account may link to the offset mortgage account, and family members of the borrower can link their savings accounts to the mortgage account to reduce the amount of the principal, and thus, the interest on the remaining balance.
For example, the Smith family has an offset mortgage. The principal is $225,000 with a 5% interest, and the family has $15,000 held in savings with no withdrawals during the last month. Calculation of interest is from $210,000 balance, which is the loan principal less the savings account balance ($225,000 – $15,000 = $210,000).
Benefits of an Offset Mortgage
An offset mortgage is an attractive option for paying back a mortgage loan primarily because the borrower can make small payments to pay down the principal instead of the interest. As more funds apply towards the principal, the loan balance reduces more rapidly.
But because these payments are to the borrower’s own savings account, the borrower still has the use of their money if needed. This flexibility gives the borrower all the benefits of paying back the mortgage quickly, but also the benefits of saving money in an investment account.
By keeping the monthly mortgage payment the same, a borrower pays down the actual principal of the mortgage more rapidly, as the part of the monthly payment that goes to the interest is smaller, since the remainder goes to the principal.