Offset mortgages are common in the United Kingdom, Australia, and New Zealand, but they can look different in the United States. Here’s how they work, when they might make sense for borrowers, and what alternatives are available in the U.S.
Definition and Examples of an Offset Mortgage
An offset mortgage is a type of mortgage that allows borrowers to use their savings to offset the amount (the principal balance) on which they’re charged interest on the mortgage note. The “offset” is reached by subtracting the amount you have in savings from the principal balance of the mortgage. The resulting offset mortgage amount is the amount on which you’re charged interest, rather than the original principal on the mortgage.
The Offset Formula
An offset mortgage can be expressed as a formula like this: Principal on the mortgage - the amount in savings = offset mortgage amount For example, the offset amount would be $280,000 if you have a $300,000 mortgage and you place $20,000 in savings ($300,000 - $20,000 = $280,000).
Effect on the Loan
Interest charged on a $300,000 mortgage at a 3% rate would result in a monthly payment of $1,264. If that same mortgage was offset by $20,000 in savings (reducing it to $280,000), then the interest charged on it would result in a monthly payment of $1,180. This is a savings of $84 per month, $1,008 per year, and $30,240 over the course of 30 years. You’ll reduce the amount of interest you’re paying on your mortgage instead of earning interest on the amount you’ve deposited in your savings account when you link your accounts. Saving on interest means you could have a lower payment and maybe even pay off your mortgage more quickly as a result. More savings deposited with a bank means less interest paid on a mortgage. The savings deposit doesn’t pay down the balance of the mortgage. The bank will take the amount in savings off the mortgage note and only charge interest on the remaining amount, but you’ll still owe the original principal amount.
Alternative names: All-in-one mortgage, money merge account
How Does an Offset Mortgage Work?
You can get an offset mortgage in two ways. Borrowers who are already in their homes can check with their lender to find out if their mortgage is eligible for an offset. Borrowers must usually have a variable rate mortgage to link to a savings account. They’ll have to wait until their term ends if they have a fixed rate loan. They can renew with a variable rate mortgage that’s eligible for an offset savings account after that point. New borrowers can set up an offset mortgage from the get-go from a lender of their choice. Banks compare the offset savings account to a home equity line of credit (HELOC) linked to the original mortgage. It lowers the principal of the mortgage when money is deposited into the account. The bank calculates interest each day based on the lower principal. Like a HELOC, the money can be withdrawn at any time for any purpose. But the interest charges will be higher when money is withdrawn, and there’s less money in the account to offset the mortgage.
Do I Need an Offset Mortgage?
If you have a savings account, linking it to an offset mortgage may make sense. You also may want to consider an offset mortgage if you would like to apply savings to your mortgage’s principal while maintaining access to the funds. Savings that are deposited into an offset mortgage won’t earn interest. Most borrowers aren’t disappointed by missing out on a few pennies or dollars earned in interest when they save substantially more by offsetting their mortgage.
Alternatives to an Offset Mortgage
An all-in-one mortgage or money merge account in the U.S. is similar to the concept behind an offset mortgage in the U.K., but there are some key differences. Both the offset mortgage and the all-in-one or money merge accounts decrease the amount of interest owed by keeping savings balances high in an “offset” account. The all-in-one mortgage is unique in that it’s a first-position HELOC. The idea behind an all-in-one mortgage or money merge account is to keep daily balances high to decrease interest paid on a mortgage.
Offset Mortgage vs. Traditional Mortgage
An offset mortgage is different from a traditional mortgage in a number of ways:
