A loan offset typically refers to a feature offered by some lenders that allows borrowers to use funds held in a savings or transaction account to offset the balance of their outstanding loan, such as a mortgage or personal loan. Instead of earning interest on the savings account, the balance is used to reduce the amount of interest charged on the loan.
Here's how a loan offset works:
Savings Account: The borrower maintains a savings or transaction account with the same financial institution that holds the loan. This account is linked to the loan and referred to as the offset account.
Offsetting Balance: The funds held in the offset account are considered as an offsetting balance against the outstanding loan balance. For example, if the borrower has a $200,000 mortgage and $20,000 in the offset account, the interest is calculated on the net balance of $180,000 ($200,000 - $20,000).
Interest Savings: By offsetting the loan balance with the funds in the offset account, the borrower effectively reduces the amount of interest charged on the loan. This can lead to significant interest savings over the life of the loan.
Flexible Access: Borrowers typically have flexible access to the funds in the offset account. They can deposit and withdraw money as needed without affecting the offsetting balance or incurring penalties. However, withdrawing funds may reduce the interest savings on the loan.
Loan Repayment: The borrower continues to make regular loan repayments based on the original loan terms. The loan term and repayment schedule remain unchanged, but the interest charged on the loan balance is reduced due to the offsetting funds.
Loan offsets are commonly offered with variable rate mortgages and home equity lines of credit (HELOCs). They provide borrowers with a way to save on interest costs while maintaining access to their savings for other purposes. Additionally, because the funds in the offset account are not directly used to repay the loan, borrowers may still be eligible for tax benefits associated with mortgage interest deductions, depending on their jurisdiction
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