Offset Mortgages: Definition, Benefits, And Examples
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Summary:
Offset mortgages are a unique home loan option that allows you to blend a traditional mortgage with your savings account. By offsetting your mortgage balance with your savings, you can significantly reduce your interest payments. This approach offers an appealing way to pay off your mortgage faster while retaining financial flexibility. This article explores the concept of offset mortgages, their benefits, and provides an illustrative example.
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What is an offset mortgage?
An offset mortgage is a financial product that integrates elements of a traditional mortgage with one or more deposit accounts within the same financial institution. This arrangement allows you to utilize the balance in your deposit account to offset your mortgage balance, effectively reducing the interest you need to pay.
Understanding offset mortgages
An offset mortgage is an attractive option for individuals who are diligent savers. While the linked savings account may not earn interest during the loan’s term, it’s important to note that typical savings accounts offer relatively low-interest rates, typically around 1% to 3% per year.
Since mortgage interest rates are substantially higher than savings account rates, the funds in your savings account effectively contribute to reducing your overall borrowing costs. Additionally, the foregone interest on your savings account is directed toward mortgage payments and is often non-taxable.
The savings account linked to an offset mortgage is generally non-interest bearing, allowing the bank to earn a positive return on any balances held in the account. The calculation of interest on your mortgage is based on the remaining balance of the loan, minus the aggregate savings in your deposit accounts.
If you withdraw funds from the account, your next mortgage payment will be calculated on a higher principal balance. In some cases, more than one savings account may be linked to the offset mortgage, and family members can also link their accounts to reduce the principal amount and, consequently, the interest.
Example of an offset mortgage
Let’s consider an example to illustrate how an offset mortgage works. The Smith family has an offset mortgage with a principal balance of $225,000 and an interest rate of 5%. They also maintain a savings balance of $15,000 with the same lender, and there have been no withdrawals from the savings account in the last month. The calculation for the next interest payment on the offset loan would be based on the $210,000 balance, which reflects the loan principal minus the savings account balance: ($225,000 – $15,000 = $210,000).
Benefits of an offset mortgage
Offset mortgages offer several benefits, making them an attractive option for paying back a mortgage loan. The primary advantages include:
- Ability to make small payments toward the principal, reducing the loan balance more rapidly.
- Flexibility to access your savings for other needs.
- The opportunity to save on interest payments, as the savings offset the mortgage balance.
The bottom line
Offset mortgages are a compelling financial option for individuals looking to pay off their mortgage while maximizing their savings. By linking your mortgage with your deposit accounts, you can accelerate the reduction of your loan principal, saving on interest payments. While not available in the United States due to tax regulations, offset mortgages are a standard offering in many other countries. This unique approach offers both financial flexibility and the potential to save money, making it a viable choice for diligent savers.
Frequently asked questions
How do offset mortgages differ from traditional mortgages?
Offset mortgages allow you to link your mortgage with your savings account, reducing the interest you owe. Traditional mortgages don’t offer this feature.
Are offset mortgages available in the United States?
No, due to U.S. tax regulations, offset mortgages are not currently available in the United States. The closest alternative would be an all-in-one mortgage.
Can multiple savings accounts be linked to an offset mortgage?
Yes, in some cases, more than one savings account may be linked to an offset mortgage, potentially reducing the mortgage principal and associated interest.
Is the interest earned on the linked savings account taxable?
The interest earned on the linked savings account is often non-taxable when used to offset mortgage payments. However, it’s advisable to consult with a tax professional for precise information.
How do I calculate the interest savings with an offset mortgage?
The interest savings can be calculated by subtracting the balance in your linked savings account from the mortgage principal. The lower the principal, the less interest you pay.
Key takeaways
- Offset mortgages allow you to blend a traditional mortgage with your savings account.
- By offsetting your mortgage balance with your savings, you can significantly reduce your interest payments.
- Offset mortgages are not currently available in the United States due to tax regulations.
- This approach offers an appealing way to pay off your mortgage faster while retaining financial flexibility.
- They provide the opportunity to save on interest costs and make efficient use of your savings, making them a valuable option for those who are diligent savers.
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