An offset mortgage is a flexible mortgage arrangement most commonly used in the United Kingdom. This arrangement nets together the outstanding balance on a mortgage with the balance in a linked non-interest-bearing bank account. By doing so, the resulting interest charge on the mortgage is reduced by the balance in the linked bank account. The reason why the linked account does not bear interest is that the funds are instead being used to reduce the interest expense associated with the mortgage.
The net effect of an offset mortgage is to allow a home owner to pay off a mortgage within a shorter period of time than would be the case with a fixed mortgage, since each monthly payment contains a larger proportion of principal repayment than interest payment.
Also, the home owner is likely to realize a larger interest expense reduction on the mortgage than the amount of interest income that is lost on the non-interest-bearing bank account, since mortgage rates are typically much higher than the interest rates offered by banks on savings accounts.
Another advantage of an offset mortgage is that the home owner still has access to the cash in the bank account. If he needs to use the cash, he can do so at any time; doing so merely reduces the amount of cash that would otherwise have been offset against the mortgage, resulting in a higher interest payment.
A final advantage is that a home owner can see how the balance in their savings account is being used to reduce the cost of their mortgage, which is an incentive to save more money and store it in the linked bank account.
There are some disadvantages to an offset mortgage. The interest rate applied to them is a variable rate, so there is a risk that the rate will increase over time. Also, the lender may charge an annual fee to maintain the arrangement. These issues mean that a home owner must balance the possible reduction in the duration of a mortgage against the risk of incurring higher fees.
Due to the different treatment of interest income and expense by the Internal Revenue Service, it is not possible to have all of the features of an offset mortgage product in the United States.
For example, a homeowner has a remaining mortgage balance of $250,000, and a cash balance in a savings account of $40,000. The interest on the mortgage will be calculated based on a net mortgage balance of $210,000.
An offset mortgage is also known as an all-in-one mortgage.