What Is an Offset Mortgage?
An offset mortgage is a type of home loan that involves blending a traditional mortgage with one or more deposit accounts held by the same financial institution. The savings balance maintained in the deposit account may then be used to offset the mortgage balance, lowering interest payments due.
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.
- An offset mortgage involves combining aspects of a traditional mortgage with one or more deposit accounts at the same financial institution.
- The funds in the deposit accounts are then used to offset the mortgage balance, lowering monthly payments.
- 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.
Understanding Offset Mortgages
An offset mortgage is a desirable option for 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 that pay only 1% to 3% per year, or less.
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 toward the mortgage.
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.
The calculation of interest is on the remaining balance of the note, less the aggregate amount of savings in 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.
Example of an Offset Mortgage
The Smith family has an offset mortgage. The principal is $225,000 with a 5% interest rate, and the family has $15,000 held in savings with the same lender with no withdrawals during the last month. Calculation of the next interest payment on an offset loan would be based on the $210,000 balance, which reflects 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 toward the principal, the loan balance reduces more rapidly.
At the same time, 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.