Offset Mortgage: All You Need to Know
With an offset mortgage, your savings account with your lender is linked to the amount you have borrowed. Interest is then only applied to the net amount owed. The amount of your existing mortgage will be “offset” by the sum currently sitting in your savings account.
You may be able to lower the sum of your mortgage on which you are paying interest by using an offset account, which links your savings and checking accounts to your mortgage balance.
Read on to learn more about offset mortgages, including the benefits and drawbacks.
What Is an Offset Mortgage?
Borrowers with an offset mortgage can reduce the interest they pay by using savings to reduce the principal balance of their loan.
You can calculate your “offset” by deducting your savings from your mortgage’s principal. The interest you pay is calculated not on the original mortgage principal, but on the amount after the offset has been applied.
No interest is accrued on savings while using an offset mortgage. However, an offset mortgage may still enable you to save money because mortgage interest is typically higher than the interest you earn on a savings account. As a result, you can make your savings account balance produce more income.
Furthermore, while offset mortgages are standard in the UK, AU, and NZ, they may take on a distinct form in the US.
How Does an Offset Mortgage Work?
There are two ways to obtain an offset mortgage. To begin, new borrowers have the option of working with any lender they like to open an offset mortgage right away. Secondly, current homeowners should contact their mortgage provider to inquire as to whether or not an offset is an option for their mortgage.
For the most part, borrowers can only link their mortgage to a savings account if they have a mortgage with a variable interest rate. If they’ve taken out a fixed-rate loan, they won’t be able to refinance until the term is up. Afterward, they are free to switch to a new mortgage with a variable interest rate and an offset savings account.
In addition, financial institutions often use the comparison of a HELOC tied to the primary mortgage to describe the offset savings account. When you make a payment into your mortgage savings account, it goes toward paying down the principal.
The bank will use the lower principal each day to determine interest. The funds are available for withdrawal at any moment, similar to a HELOC. Withdrawing funds, however, will increase interest costs and reduce the account’s ability to pay down the mortgage.
Furthermore, the value of your funds is unaffected by an offset mortgage. They are instead “offset” against your mortgage by being held in an “offset savings account” with your mortgage lender.
The interest you pay on a mortgage of £300,000 would be reduced to £260,000 if you had savings of £40,000. Interest payments on a £60,000 mortgage at a 2% rate drop to £5,200 per year, a savings of £800.
However, you should subtract the lost interest from the overall amount saved. If you were receiving 0.5% interest upon the £40,000, or £200 annually, you’d have £600 more to put toward your mortgage.
Lastly, you have the option of reducing your monthly payment or shortening your mortgage term when you use an offset mortgage. Both options allow you to pay off your mortgage faster, but the first one lowers your monthly payments while the second maintains them constant.
Offset Mortgage vs. Traditional Mortgage: What’s the Difference?
There are many key distinctions that you should be aware of when deciding between an offset mortgage and a traditional mortgage.
The borrower of a traditional mortgage does not have to establish a connection between the loan and a savings account because it is a separate financial obligation. In contrast, an offset mortgage requires a savings account, typically at the same bank.
When compared to a traditional mortgage, which requires you to pay interest on the full balance, an offset mortgage enables you to pay interest on the balance lower amount you possess in a linked savings account.
Plus, with a traditional mortgage, the debtor receives interest on a savings account, whereas, with an offset mortgage, the debtor does not.
Finally, an offset mortgage is only utilized in conjunction with a variable rate mortgage, whereas a traditional mortgage can have either a fixed or variable interest rate.
Offset Mortgage: Pros and Cons
The borrower can reduce their interest payments on their mortgage by keeping their savings in the same account with the same banking institution (thus the name “offset mortgage”), but this option is typically only available for those with a variable interest rate loan. The pro and cons of an offset mortgage are outlined below.
- The sum due may be reduced. Your mortgage payment may be reduced if you make savings deposits equal to the amount of interest accrued on the loan’s principal. The more money you put into savings, the less interest you’ll earn, and the less you’ll have to pay overall.
- May be able to get the mortgage paid off faster. Overpayments are made by borrowers using interest savings to pay off their mortgages earlier than the loan’s scheduled maturity date.
- Obtaining access to funds right away. Because it is not being deducted from the principal, savings funds should still be easily accessible. This allows borrowers to put their savings toward paying down their mortgage balance without having to wait.
- Access to overpayment funds or a break in payments is possible. If you’ve made additional payments on your offset mortgage, the bank can let you access those funds again. If you’ve overpaid on your mortgage, your lender may allow you to temporarily suspend payments.
- Higher rates of interest are possible. Since the interest rate on an offset mortgage is variable, it is possible that it will increase over time.
- Payment schedules might vary from monthly to annual to one-time. In some cases, the use of an offset account will cost you money each month or once a year. In most cases, fees must be paid upfront with an all-in-one or money-merge mortgage, making it more challenging to justify the overall cost.
- Loans with a variable interest rate are the usual. You can’t use an offset mortgage product to go from a fixed-rate to a variable-rate loan before the term ends.
- There are not many available U.S. lenders. In the United Kingdom, Australia, and New Zealand, the offset mortgage is significantly more widespread than in the United States.
In the United States, such products are referred to as “all-in-one mortgages” or “money merge accounts” by the lenders that provide them. In essence, these are first-position HELOCs rather than savings-account-linked mortgages.
Do You Need an Offset Mortgage?
Connecting your savings account to your mortgage could be beneficial. If you want to make payments on your mortgage principal from the money you’ve saved but still have access to, you might want to look into an offset mortgage.
If you have an offset mortgage, your savings will not accumulate interest. To most borrowers, the loss of a few dollars or pennies in interest is negligible in light of the thousands or tens of thousands of dollars they can save by mortgage offsetting.
Alternatives to an Offset Mortgage
While the idea behind an offset mortgage in the United Kingdom is similar to that of a money merge account or an all-in-one mortgage in the United States, there are important distinctions.
Interest payments can be reduced with an offset mortgage or an all-in-one or money-merge account by holding a large savings balance in an “offset” account. The first-position HELOC is what makes the all-in-one mortgage stand out.
The goal of a money merge account or an all-in-one mortgage is to reduce mortgage interest costs by maintaining a large balance at all times.
When you get a traditional mortgage, interest is calculated based on the amount you borrow plus the interest you’ve already paid on the property you’ve already bought. With an offset mortgage, things are handled a little differently.
With an offset mortgage, your savings account with your mortgage creditor is linked to the amount you have borrowed from them. When this occurs, interest is only applied to the net amount owed. Your mortgage balance is “offset” by the number of funds in your savings account.
A substantial amount of money can make a difference in the size of your mortgage repayments and the quickness with which you can pay off your loan through the use of an offset mortgage.
The way an offset mortgage is utilized is also flexible. With this option, you can maintain making payments at the same rate you would with a standard mortgage, but pay off your loan much sooner.
However, it’s important to keep in mind that the interest rates on offset mortgages are often higher than the rates on conventional mortgages. Because of this, you need to do the math to ensure that you have sufficient funds to use an offset mortgage reasonably.