How Offset Mortgages Work
Offset mortgages are an innovative financial product that can help homeowners in New Zealand save on interest costs and pay off their home loans faster. By linking your mortgage to one or more deposit accounts, the balance in these accounts is used to offset the amount of interest you pay on your home loan. This article explains how offset mortgages work, their benefits, and considerations for New Zealand homeowners.
What is an Offset Mortgage?
An offset mortgage combines aspects of a traditional mortgage with one or more deposit accounts held at the same financial institution. The funds in these deposit accounts are used to offset the mortgage balance, thereby reducing the interest payments due. In essence, the more you save, the less interest you pay on your mortgage.
For example, if you have a home loan of $400,000 and $50,000 in your linked savings accounts, you will only pay interest on $350,000. This reduction in the principal amount on which interest is calculated can lead to significant savings over the life of the loan.
How Offset Mortgages Work
- Linking Accounts Offset mortgages work by linking your mortgage to one or more of your everyday or savings accounts. According to Kiwibank, you can link up to eight accounts, including those of family members like your spouse, children, or parents. The total balance in these accounts is used to offset your mortgage balance, reducing the amount of interest you pay.
- Interest Calculation Interest on an offset mortgage is calculated daily based on the reduced principal balance. For instance, if you have a $300,000 mortgage and $20,000 in linked accounts, interest is calculated on $280,000. This daily calculation ensures that any fluctuations in your account balances are immediately reflected in your interest savings.
- Variable Interest Rate Most offset mortgages come with a variable interest rate, which means the rate can change in response to market conditions. This flexibility allows you to benefit from falling interest rates, but it also means you need to be prepared for potential rate increases.
- Access to Funds One of the key benefits of an offset mortgage is that you retain full access to the funds in your linked accounts. You can deposit or withdraw money as needed, and the interest calculation will adjust accordingly. This flexibility makes offset mortgages an attractive option for those who want to maintain liquidity while reducing their mortgage interest.
Benefits of Offset Mortgages
- Interest Savings The primary benefit of an offset mortgage is the potential for significant interest savings. Because the interest is calculated on a reduced principal balance, you can save thousands of dollars over the life of the loan. For example, Westpac NZ illustrates that with a $300,000 mortgage and $25,000 in savings, you could save more than $78,000 in interest and pay off your home loan nearly four years sooner.
- Tax Efficiency Interest saved through an offset mortgage is not considered taxable income, unlike interest earned on a savings account. This tax efficiency can enhance the overall financial benefits of an offset mortgage, as noted by ANZ.
- Flexibility Offset mortgages offer flexibility in managing your finances. You can make extra repayments without penalty, adjust your regular repayments, and access your savings whenever needed. This flexibility can be particularly beneficial for those with irregular income or fluctuating financial needs.
- Family Participation Some banks, like BNZ, allow you to link multiple accounts, including those of family members, to your offset mortgage. This collective approach can amplify the interest savings and help you pay off your loan faster.
Considerations and Potential Drawbacks
- Higher Interest Rates Offset mortgages often come with higher interest rates compared to standard fixed-rate mortgages. It’s essential to compare the offset mortgage rate with other available options to ensure that the potential interest savings outweigh the higher rate.
- No Interest on Linked Accounts While your savings are offsetting your mortgage interest, you won’t earn interest on the linked accounts. This opportunity cost should be considered, especially if you have substantial savings that could otherwise earn interest.
- Fees and Charges Some banks may charge fees for maintaining an offset account or for linking multiple accounts. It’s important to review the fee structure and ensure that the savings from the offset mortgage justify any additional costs.
- Suitability Offset mortgages are not suitable for everyone. They are most beneficial for diligent savers who maintain substantial balances in their linked accounts. First-home buyers or those with limited savings may not derive as much benefit from an offset mortgage.
Offset mortgages offer a unique and flexible way to reduce interest costs and pay off your home loan faster. By linking your mortgage to one or more deposit accounts, you can leverage your savings to lower the principal balance on which interest is calculated. While there are significant benefits, including interest savings, tax efficiency, and financial flexibility, it’s essential to consider the higher interest rates, potential fees, and opportunity costs. By understanding how offset mortgages work and evaluating your financial situation, you can determine if this innovative mortgage option is right for you. For personalised advice, consult with a financial adviser or mortgage specialist to explore the best options for your needs in the New Zealand property market.