An offset mortgage allows a borrower to pay less interest on a mortgage if they deposit savings with the same financial institution. The amount of savings is then subtracted from the balance of the mortgage, offsetting the total amount on which the borrower will pay interest.
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.
Savings must typically be deposited with the same financial institution, and your mortgage must be eligible for an offset account.
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.
Borrowers can link multiple accounts to increase the savings offset. The higher the average daily balance, the more you'll save on interest.
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.
You can plug your numbers into Barclays's offset mortgage calculator to find out how much you’ll save with an offset 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:
|Traditional Mortgage||Offset Mortgage|
|Stand-alone mortgage||Must be attached to a savings account, usually with the same financial institution|
|No linked savings account||Linked savings account|
|Pay interest on the full balance||Pay interest on the balance less the amount you have in a linked savings account|
|Earns interest on savings account||Does not earn interest on a savings account|
|Can be a fixed or variable interest rate mortgage||Typically only used with a variable rate mortgage|
Pros and Cons of an Offset Mortgage
- Payment could be lower
- Could pay off mortgage sooner
- Instant access to savings
- May be able to access overpayment funds or take a payment holiday
- Interest rates can be higher
- May be charged monthly, yearly, or upfront fees
- Generally only available on variable rate loans
- Few U.S. lenders to choose from
- Payment could be lower: Interest is calculated on the principal offset by the amount of money that's deposited in savings, so your mortgage payment could be lower as a result. The more you deposit in savings, the lower the interest, thus reducing the payment.
- Could pay off mortgage sooner: Borrowers can use the savings from reduced interest payments to make overpayments, resulting in a mortgage that's paid off sooner than the original loan maturation date.
- Instant access to savings: You should still have instant access to your money in savings because it's not applied to the principal. This gives borrowers immediate access to their savings while still applying the amount to the principal to reduce the interest charged on the mortgage.
- May be able to access overpayment funds or take a payment holiday: Your bank may let you use that money again if you've paid extra on your offset mortgage. You may also have the option of taking a break from making payments if you’ve overpaid on your mortgage.
- Interest rates can be higher: The offset mortgage is a variable rate, so you may end up paying a higher interest rate.
- May be charged monthly, yearly, or upfront fees: You may have to pay a monthly or annual fee for an offset account. All-in-one or money merge mortgages will typically charge upfront fees, which can make it harder to justify the cost.
- Generally only available on variable rate loans: You’ll have to wait until your term expires to switch from a fixed to a variable rate loan to use an offset mortgage product.
- Few U.S. lenders to choose from: The offset mortgage is much more common in the U.K., Australia, and New Zealand than in the United States. Lenders in the U.S. that offer similar products call them “all-in-one” mortgages or money merge accounts. These are essentially first-position HELOCs rather than mortgages linked to savings accounts.
- An offset mortgage can lower your monthly payments or help pay off a mortgage more quickly.
- Interest is charged on the amount of principal offset by a linked savings account.
- The amount deposited into a linked savings account doesn’t pay down the principal on a mortgage, but it helps lower interest charges by offsetting the principal balance.