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An interest offset refers to a reduction in interest rates due to interest credits awarded to a borrower for one reason or another.
While such arrangements can be created for all types of consumer credit products, the term is usually used to refer to home loans whereby the borrower maintains an account, savings or current, with the lender in exchange for a reduction in mortgage rates.
These types of property loans can also be called an offset mortgage.
For example, a regular home loan of $500,000 might have an interest rate of 3%. But the bank offers the borrower a 1% discount on a portion of the loan amount equal to what is deposited into an offset account. If the borrower puts $100,000 into that account, then $100,000 of the $500,000 loan would be charged at 2% instead of 3%.
The result is that the borrower would incur less interest costs.
Different lenders might structure their offset interest facilities differently. There is no standard practices and offerings that all financial institutions adhere to.
It must be noted that the reduction in interest does not mean a reduction in monthly payments.
The monthly payment amount remains the same. Just that the portion that goes towards interest due is less. The excess will then be used to pay off the principal.
For example, an outstanding loan with a monthly repayment obligation of $3,000 might consist of $500 interest and $2,500 principal. If an interest offset facility enables a $100 reduction in interest costs, then only $400 of the $3,000 payment would go towards interest charges. The amount that goes towards principal reduction would then become $2,600. This means that more money goes towards paying the principal loan balance.
The net result would be that the home loan could be paid off earlier than the original tenure. This helps the borrower to possibly save on interest charges amounting to a few payment cycles.
It would also go without saying that the larger the loan size, the larger the savings in real dollars.
From the lenders’ point of view, additional deposits enables them a cheaper way to accumulate funds, which they would in turn lend to other borrowers.
The costs of funds is technically zero and what they are paying for these funds is essentially an opportunity cost that a home loan would have generated interest or otherwise.
Should you sign up for such loan facilities?
Such types of credit facilities are obviously meant for homeowners, home buyers and consumers with excess funds sitting around in their personal savings or current accounts.
Investors or higher risk takers would put their excess funds in other investment vehicles that generate a nice return for themselves. Putting that money in an account that creates a 1% savings is not exactly attractive for investors.
However, even the most experienced investors would keep an emergency fund somewhere for unpredictable events.
So putting those emergency funds into an interest offset account can be useful, provided there are no restrictions on withdrawals. This is also assuming that their personal banks are not offering an interest rate on their funds.
For the typical homeowners with savings in the bank, consider that the interest earned on regular savings accounts are less than 1% unless the funds are of considerable size.
So if the interest offset on your home loan is more than 1%, then it can make sense to use your excess funds for such home loans.
Remember that you would be giving up on the interest earnings of the funds with interest offset accounts. You would not see your money grow as the funds earn credits which are used against the home loan.
There are currently 3 interest offset mortgages available to general consumers in Singapore.
- HSBC SmartMortgage
- SCB MortgageOne
- CIti Home Saver
While their concepts are the same, the details are structured very differently.
Which one to choose really depends on personal preferences and the specific situation of the borrower in general.
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