A unique mortgage type that came to the U.S. market just a few years ago is gaining popularity and can offer significant advantages for borrowers with good cash flow and savings. Sometimes referred to as an “offset account” it operates as a first lien, equity line of credit that is joined to a full service checking account. Variations of this loan have been some of the more popular home financing options in the UK and Australia for many years, so it has a proven track record. However, don’t expect major U.S. banks to follow suit anytime soon as it would cut into their profits. For now, they offer offset loans only to their largest depositors.
This mortgage, marketed by just a few banks (including CMG as the Homeowner Accelerator or HOA), essentially marries a borrower’s mortgage to their checking account and can greatly reduce the compound interest one would pay on a conventional mortgage. Borrowers are encouraged to deposit their salaries and any other income sources into the account in order to decrease the principal balance that interest is charged against. Since mortgage interest is calculated daily, even if most of a paycheck is used by month’s end to meet household obligations, borrowers still get credit for deposits while the money sits in the account. This can quickly outpace other methods for compound interest reduction such as bi-monthly mortgage payments. Since deposited funds receive credit at the same interest rate the mortgage balance is being charged, cash reserves such as CDs earning 1% to 2% are perhaps better deployed by being deposited into the mortgage account.
With conventional 30-year fixed financing, even a relatively low 5% rate incurs an interest cost of around 93% over the life of the loan. Interest payments are forward-weighted, with 25% of the interest collected in the first 5 years and it is only after approximately 17 years that the majority of one’s mortgage payment goes toward principal reduction. Whereas compound interest could also be greatly reduced on conventional loans through overpayment, most borrowers hesitate to do so since they cannot access their equity without refinancing their mortgage. With the HOA, deposited funds can be withdrawn at any time, making overpayment a more attractive option. The product can also work well for borrowers with strong though sporadic earnings as they can draw against the line when cash flow is more limited and catch up with bonus money or other anticipated windfalls.
Although the HOA offers greater flexibility and the potential to reduce compound mortgage interest costs, it is suited to a relatively small audience of well-heeled mortgage shoppers. The line is adjustable and tied to the one-month Libor with a life cap currently set at around 9.5%. Purchase money loans go as high as $2.5 million, and the minimum down payment requirement begins at 25%. It is a 30-year mortgage with an initial full draw 10-year interest only period that is followed by amortized payments during the final 20 years of the loan with the line amount reduced 1/240 each month until the line is closed out.
Promoters of this product suggest it benefits those whose savings run at around 10%. It is probably better suited, however, for borrowers with significantly higher rates of savings as one should have the means to support contributions toward retirement and other investments opportunities. It is also geared toward disciplined savers and those able to side-step the temptation of dropping by their local ATM to draw against their home’s equity at any time. For strong borrowers with good cash flow and large deposits earning next to nothing from the same institution looking to lend them money at, say 5%, this might be the perfect way to have your cake and eat it, too.
Nicholas Ballard is both a mortgage broker and banker specialized in the residential Marin market. For assistance, please call or e-mail:
Nicholas Ballard: 415-526-1941; firstname.lastname@example.org
Real Estate Financing
CA Dept. of Real Estate #01356374
California Mortgage Advisors, Inc.
CA Dept. of Real Estate #01170868
Redwood Highway, San Rafael 94903