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How does an offset mortgage work?

How does an offset mortgage work? Can I use an offset mortgage to reduce the length of my mortgage?

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

With an offset mortgage, the balance in a savings account is used to "offset" your mortgage balance when calculating how much interest you owe with each monthly mortgage payment. For example, if your mortgage balance is $150,000 and you have $150,000 in an offset savings account, then the interest due with your monthly mortgage payment is $0 because $150,000 (mortgage balance) - $150,000 (offset account) = $0. This does not mean you are not required to make your regularly scheduled monthly mortgage payment based on your initial mortgage terms but rather 100% of your payment goes to pay down your principal mortgage balance as opposed to most mortgage payments which are comprised of a mix of both principal and interest.

As another example, if your mortgage balance is $150,000 and you have $50,000 in an offset account, then the interest due with your monthly mortgage payment is based on a $100,000 loan balance ($150,000 mortgage balance - $50,000 offset account balance = $100,000) and whatever the interest rate on the mortgage is. Again, you still make your regularly scheduled payment based on the terms when you received your mortgage but more of your payment goes to pay down principal as compared to a mortgage without an offset account.

In short, an offset account enables borrowers to pay down their mortgage balance faster, which reduces the length of your loan and saves you money on mortgage interest expense. Paying more principal than required is also called mortgage acceleration. We provide a comprehensive overview of mortgage acceleration on FREEandCLEAR.

The downside to an offset mortgage is that you do not earn any interest on the offset account balance, which is a disadvantage for borrowers.

We answer some of the more common questions about offset mortgages below:

1) Does an offset mortgage enable me to reduce the term, or tenor, of my loan?

Yes. Using an offset account reduces your mortgage term. For example, if you maintained an offset account equal to your mortgage balance for the entirety of your mortgage, you could almost cut the length of your mortgage in half.  Using an offset account reduces your mortgage term because you pay more than the required principal amount with each payment. Overpaying, or accelerating, your mortgage reduces your loan term, or tenor, and save you money on interest expense.

2) Do I pay full interest rate according to the original terms of my mortgage?

Yes. Using an offset account does not change the interest rate on your mortgage. Using an offset account changes the principal balance used to calculate the interest expense you own with each mortgage payment but the actual mortgage rate does not change. If you have an offset account that equals your mortgage balance, however, the amount of interest you owe with your payment is zero because your mortgage balance is zero according to the way offset accounts work. If you were to eliminate the offset account, your monthly payment would be based on your mortgage rate and mortgage balance at that time.

3) If I maintain an offset account equal to my mortgage balance, do I pay any interest?

No. If you maintain an offset account that equals your mortgage balance over the entirety of your mortgage then you would pay no interest expense. With an offset account, the mortgage balance used to calculate your monthly interest expense equals your outstanding mortgage balance minus the amount of your offset account. So if your offset account equals your mortgage balance then you effectively have no mortgage balance, which means you pay no interest. In this case 100% of your mortgage payment goes to pay down principal as opposed to a standard mortgage where part of your payment goes to pay interest. Please note that you do not need to maintain your initial loan amount in the offset account over the entirety of your mortgage.  As you pay down your mortgage balance with every payment, your offset account can be reduced as well.

Please note that true offset mortgages are not permitted in the United States due to tax issues and are more common in Australia and the United Kingdom.

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About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry

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