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What Is an Offset Mortgage?
Let me explain what an offset mortgage is. It's a type of home loan where you blend a traditional mortgage with one or more deposit accounts at the same financial institution. The balance in your savings account offsets the mortgage balance, which directly lowers the interest you pay.
Availability and Alternatives
You should know that offset mortgages are common in places like the United Kingdom, but they're not available in the United States because of tax laws. If you're in the U.S., the closest thing you'll find is an all-in-one mortgage.
Key Takeaways
- An offset mortgage merges traditional mortgage features with deposit accounts at the same institution.
- Savings in those accounts offset the mortgage balance, reducing your monthly payments.
- They're standard in many countries, but U.S. tax laws prevent them.
- This setup lets you make smaller payments that go toward the principal rather than just interest.
How an Offset Mortgage Works
If you're a diligent saver, an offset mortgage could suit you well. The linked savings account doesn't earn interest during the loan term, but most savings accounts only pay low rates anyway, like 1% to 3% or less. Your mortgage interest rate is typically much higher, so offsetting with savings gives you a net benefit. Plus, the interest you forgo on savings becomes non-taxable progress on your mortgage.
Keep in mind that the savings account is usually non-interest bearing, allowing the bank to profit from the balances. Interest is calculated on the mortgage balance minus the total savings in linked accounts. You can still access your savings, but withdrawing funds means your next payment calculates on a higher principal.
You can link multiple savings accounts, and even family members can connect theirs to help reduce the principal and interest.
Example of an Offset Mortgage
Consider the Smith family with an offset mortgage. Their principal is $225,000 at 5% interest, and they have $15,000 in savings with the lender, untouched last month. The next interest payment bases on $210,000, which is the principal minus savings: $225,000 – $15,000.
Benefits of an Offset Mortgage
One major draw is that you can make smaller payments directly toward the principal, not just interest, so the loan balance drops faster. At the same time, since these payments build your own savings, you retain access to the money if needed. This gives you the perks of quick repayment and the security of an investment account.
What Are the Benefits of an Offset Mortgage?
The primary benefit is smaller payments going straight to principal, helping you pay off the mortgage quicker than interest-focused payments. You also keep access to funds in your account.
What Are the Downsides of an Offset Mortgage?
On the flip side, you won't earn interest on your savings, and you might face higher mortgage interest rates and fees. Finding a lender can be tough, as not many offer them. Remember, the U.S. bans them due to tax issues.
Is It Better to Offset a Mortgage or Pay It Off?
It comes down to your finances. Offsetting keeps savings accessible as an emergency fund, while fully paying off might leave you without that cushion.
The Bottom Line
If offset mortgages are allowed where you live, they're a solid choice for home financing. You get savings access while making smaller principal payments to clear the loan faster.
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