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What is an Offset Mortgage?

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I’ve often looked across the pond at the UK for a few novel, if not simply different, personal finance ideas and am often surprised at some of the things they have that we don’t. For example, you can open an Roth IRA-like instrument known as an Individual Savings Account (ISA) but “invest” it in a regular savings account. In the United States, you generally have to invest the assets in your IRA in something other than a regular savings account (the closest you can get to something 100% safe is a money market fund or perhaps a Treasury fund).

Another financial creature that doesn’t exist in the United States, at least in the same shape, is that of an offset mortgage account. You have versions of it here, like the money merge account which is packed with fees and charges, but nothing as clean and simple as the offset mortgage accounts you can have in the UK.

What is an Offset Mortgage Account?

An offset mortgage account is one in which you put all of your accounts together and only pay interest on the difference between your liabilities and your assets. So if you had a $100,000 mortgage but a $20,000 balance in your checking account, interest would be charged on only $80,000 – the assets “offset” the liabilities. In many cases, the credit balance doesn’t earn any interest but you “save” what you would’ve paid in mortgage interest. This makes it effectively a tax free gain and very tax efficient. (these accounts are also known as current account mortgages)

A friend of mine, who lived in the UK for years, paid off her house very quickly (think 360K GBP in under 4 years) and was surprised something like this didn’t exist in the United States. She mentioned that the biggest “shock” in setting up an offset mortgage, hers was in a One Account by Virgin Direct (at the time) and RBS, because you just saw an enormous negative number. If you can imagine, logging into your bank account and seeing -£360,000 can be a bit of a shock day in and day out, but she ended up paying it down in under 4 years (at the time they had two incomes and no children).

I think part of the reason why these aren’t more popular in the United States is because banks don’t make money when you can pay off a mortgage so quickly, lenders can’t resell loans like this, and we’ve been “trained” by marketers to think we are supposed to have a house payment, like a car payment, all the time.

I know many of you readers are far more experienced and knowledgeable about mortgage and things like this, why do you think we don’t have more of these types of accounts here?

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15 Responses to “What is an Offset Mortgage?”

  1. Meoip says:

    There are a few companies out there that sell these types of mortgages in the US. If I remember from looking a few years ago they feel very much life MLM schemes attached loosely to bank accounts.

  2. otipoby says:

    Does anyone know how the monthly payment works? Does it vary every month? Do you only have to pay the monthly interest since depositing in savings is effectivly paying principle? Is this a term loan (30yr/15yr) with the requirement to pay principle (or increasing savings balance) over time?

    This sounds very interesting as a way to increase the effective interest on savings (although you would not see the $$ until you sell).

    Now I am hungry for a scone with clotted cream :-)

  3. cubiclegeoff says:

    It’s interesting that these different mortgages exist, but in our profit driven country, the variety of mortgages tends towards ones that create greater profit. Doesn’t Canada have a similar type of account as well?

  4. I wonder what the limits are on that!??!

    Using your example, with a $100K mortgage, if you had $100K in your bank account, would that mean that you would never have to pay interest?

  5. zapeta says:

    Very interesting. My guess is that these don’t exist here because the banks wouldn’t make as much money if some of the mortgage is offset and the government doesn’t make them offer something like this.

    • live green says:

      That is exactly right. Banks are trying to make huge profits off of us instead of providing this additional option to consumers. They need to make money on those individuals who are financially responsible somehow.

  6. ye says:

    You can open an IRA with ING and invest in an FDIC insured savings account or CDs. This sounds exactly like the ISAs you describe. Even places like Bank of America offer IRA savings accounts, though the rates of return are abysmal in comparison.

    For the offset mortgage, you can pretty easily create the same functionality by combining a regular mortgage and a home equity line of credit. Only trouble is, to avoid most of the fees on the HELOC, you have to work with a low-fee company that will tend to place lower caps on total LTV. ING (I have no connection to the company, just know their products) can give you a 75% LTV HELOC where you only pay initial closing costs, but no annual fees, draw fees, or prepayment fees. You get a 10-year draw period, which is more than enough if you are planning to repay the whole line in that time.

    There are at least 2 reasons you don’t hear about these types of setups. First is that few people want to put up the necessary down payment that would be required to take best advantage of the setup and minimize fees (25% for ING). Most people are looking for low monthly payments with as little down as possible. That’s why we ended up with the default mess that we’re in now. Second is that most HELOC agreements are designed so that the lender can reduce the available credit line at will. When all your reserve cash is used to reduce the balance on the HELOC, the HELOC tends to function as your emergency fund. Should the HELOC credit line be suddenly reduced, you might face an acute cash crunch. HELOC credit lines were slashed, sometimes to zero, during the housing crisis, and usually without warning. You would need to have a prudent awareness of your financial situation before embarking on an emergency-fund-less financial strategy.

    • aua868s says:

      ye…excellent info about the IRA option in ING as a CD. Is there any other institution which offera a better rate than ING? Does a similar option exist in 401K?

  7. Raymond says:

    Yes I agree with Ye, except that you would have to have more equity in the property then the 25% because the HELOC only go up to the 75% LTV. Therefore, if you have a mortgage that is already at 75% LTV they will not alow you to have the HELOC. What I have done is I have got a mortgage on my property and then have the HELOC on one of my rentals. This allows me to have the extra cash flow that is needed so that I can make the larger payments to my mortgage. I got my mortgage in 2006 and have already been able to knock off 20% of the princaple doing it this way.

    • Howard says:

      Ray, sounds like a good approach, but I am not sure of the mechanics and how do you save money and reduce your loan payoff? Would you mind going through an example. Thank you.

  8. BarrellRyder says:

    What happens if you default on the loan? Then you may lose all of your linked assets? And yes, there are many IRA options that may be put into FDIC accounts at banks and credit unions typically only CDs or savings account that will likely, over the long haul only yield 2-4 percent at best…Does anyone know if you can purchase govt savings bonds in a roth IRA and thus never pay tax when cashing them in since they were bought with post tax dollars?

  9. ShaneD says:

    I am originally from Australia and had my original house through a loan like this..the interest is calculated daily so if you create a budget and stick to it you can really pay down a loan quicker…also in the event you need some money very very urgently for an important issue you have the flexibility to take that cash out in a straight forward manner..once u have built up some equity..I now live in USA and have been trying to find a company who does this…Everyone is right by saying traditional loans make the banks more money than these types of loans…

  10. Steven H says:

    Offset mortgages are not available in the U.S. due to IRS rules.

  11. Steven H says:

    Not in America, You Won’t
    Unfortunately, because the IRS taxes interest paid and received differently than in Britain, American offset loans operate in a slightly different manner. The IRS will not allow taxable interest paid and received to cancel each other out as in Britain and Australia; each must be reported separately. Therefore, the “offset” loans available in the U.S. cannot technically be called by this name; in order for these loans to meet IRS guidelines, they must combine a checking account, home equity loan and mortgage into one account. One account does not truly offset the other as it does in Britain. The single account offers all of the amenities of a normal bank account, such as an ATM and debit cards, automatic bill payments and a checkbook. But it allows every spare dollar the homeowner has to be used to pay down the mortgage until it is used.

    Read more: http://www.investopedia.com/articles/mortgages-real-estate/08/offset-mortgage.asp#ixzz24ZSUCCrP


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