What is an offset mortgage?
An ‘offset mortgage’ is a home loan account that gets linked to your savings and everyday transactional accounts. This enables the total balance in your savings and transactional bank accounts to reduce the amount of interest you pay towards your home loan.
How an offset mortgage works
Here is an example of how an offset mortgage works:
Offset mortgage = $100,000
Linked Accounts:
Balance of savings account = $20,000
Balance of transactional accounts: $5,000
Difference = $100,000 - $20,000 - $5,000 = $75,000
Instead of paying interest of $100,000, you will only pay interest on $75,000.
Due to the ‘offsetting effect’, a higher portion of your repayments will go towards your principal rather than interest. This essentially means you can pay off your mortgage faster and save thousands of dollars in interest repayments.
What are the advantages of an offset mortgage?
Pay off your mortgage faster and save money on interest repayments
As discussed above, offsetting your mortgage will decrease the amount of interest you pay to the bank and will pay your principal off faster.
You can have multiple linked accounts
Depending on the bank, you can link up to 50-accounts to offset your mortgage.
You can share offset account with family
This is a highly underrated feature – you can link accounts with family members (from the same bank) to increase offsetting benefits.
Tax benefits
Your savings won’t be earning any interest as it’s being used to pay off your mortgage (and decrease interest payments to the bank). Since there is no interest being earned on savings, you will not have to pay tax on the interest-earned from savings.
Make extra repayments without penalty
Offset mortgages are on the floating rate, therefore you can make extra repayments without any penalties.
Can access your savings if required
Unlike making extra payments directly into your mortgage, which can be difficult to withdraw, the money in your offset account is available when you need it.
Encourages savings
Knowing that your savings are directly reducing your mortgage interest can be a strong incentive to save more.
What are the cons of an offset mortgage?
Higher interest rates
An offset mortgage is usually on the floating rate – therefore will be higher than fixed rates.
Floating interest rates rather than fixed rates
In addition to above, floating rates fluctuate with the market and therefore uncertain.
No interest earned on savings
Interest gets offset from your mortgage and as a result you won't get interest on your savings.
Monthly fees
There are usually ongoing fees in using an offset mortgage account.
Linked accounts must be with the same bank
You need to have your linked accounts with the same bank as your offset mortgage. This can be inconvenient to move your money around.
Not all banks offer them
Only three banks in New Zealand offer them – BNZ, Westpac and Kiwibank.
Complexity
The mechanics of how offset accounts work can be complex, and it might not be the best option for everyone, particularly if your financial situation changes frequently.
Who is the offset mortgage suitable for?
Using an offset mortgage account is a powerful hack to reduce interest and pay off your mortgage faster. However, it isn’t for everyone.
Ideally offset mortgage accounts work optimally for people with savings, good spending habits and whose household income is consistently greater than expenses (including general expenses, debts and mortgage repayments).
Offset mortgage accounts have higher interest rates than fixed rates, therefore poor spending habits and lack of savings can be fatal.
Talk to a Mortgage Adviser (aka Mortgage Broker) to see if utilizing offset mortgage is right for you.
Disclaimer
The contents of this article is for information-only and may express the opinion of the writer. This article is not be taken as personalised financial advice, as everyone’s situation is different. Please always seek advice from a financial adviser before making any decisions with your personal and/or business finances.
