An offset mortgage combines a traditional home loan with one or more deposit accounts held by the same financial institution. The balance in these accounts is used to offset the mortgage balance, thereby lowering interest payments and helping you pay off the loan faster.
Offset mortgages are common in various regions, such as the U.K., but they are not currently permitted in the U.S. due to tax laws. A comparable option in the U.S. might be an all-in-one mortgage.
Key Takeaways
- An offset mortgage merges aspects of a traditional mortgage with deposit accounts at the same financial institution.
- Funds in deposit accounts are used to offset the mortgage balance, reducing monthly payments.
- Offset mortgages are typical in many countries but are not allowed in the U.S. due to current tax laws.
- Borrowers can make smaller payments towards the principal rather than larger payments towards interest, making it an attractive mortgage repayment option.
Understanding Offset Mortgages
Offset mortgages benefit those who consistently save. Although the linked savings account won’t earn interest, typical savings accounts earn only modest interest rates between 1% and 3% per year.
The mortgage interest rate tends to be higher than the rate paid on savings, so the net effect is beneficial for the borrower. Additionally, the interest saved on the mortgage becomes non-taxable payments towards the loan.
Interest is calculated on the remaining balance of the loan, less the combined balance of the linked accounts. If funds are withdrawn from the savings account, the following mortgage payment will reflect a higher principal balance.
You can link multiple savings accounts to an offset mortgage, allowing family members to contribute their own savings, thereby reducing the principal and the mortgage interest further.
Example of an Offset Mortgage
Imagine the Smith family, with a $225,000 mortgage at an interest rate of 5%, and a savings balance of $15,000, kept with the same lender. Without any withdrawals, their next interest payment would be based on a reduced balance of $210,000, calculated as follows:
$225,000 (loan principal) - $15,000 (savings) = $210,000.
Benefits of an Offset Mortgage
Offset mortgages offer the key benefit of allowing borrowers to make smaller payments that target the principal balance instead of the interest. As more money goes toward the principal, the loan reduces more quickly.
Additionally, since these payments accumulate in the borrower’s own savings account, the borrower retains access to these funds if needed. This flexibility ensures the dual advantage of paying off the mortgage sooner while still maintaining savings for other needs.
Related Terms: offset, mortgage, interest rate, savings account, principal, home loan, tax laws
References
- Barclays. “Offset Mortgages”.
- Yorkshire Building Society. “Offset Mortgages”.
