An offset mortgage is a type of hybrid mortgage where the principal balance is offset by a non-interest bearing auxiliary account--most often a savings account--established with the lending institution.

The interest due on an this type of mortgage is "offset" by the balance of your auxiliary account. Most common in the United Kingdom, offset mortgages are not offered in the United States. Calculating an offset mortgage is fairly straightforward, though in practice it can be complicated by fluctuating balances in the auxiliary account.

Determine the amount of money you are borrowing, the interest rate, term (or number of years) of the loan and how much money you have set aside in an auxiliary account to "offset" the principal balance.

Subtract the amount of money held in your auxiliary account from the principal balance of the mortgage. For example: £65,000 principal balance on the mortgage and £16,250 in an auxiliary account means that mortgage interest will be calculated on a principal balance of £48,750.

Determine how many payments you will make by multiplying the term of the loan by 12. For example, a 30-year mortgage will have 360 monthly payments.

Determine the monthly interest rate by dividing the annual interest rate by 12. For example, 5-percent interest per annum divided by 12 is .4167-per cent interest monthly.

Use the following formula to calculate your monthly payment P (R (1+R) ^N) / ((1+R) ^(N-1). P is your principal balance (offset by the amount held in an auxiliary account), R is your monthly interest rate, N means number of payments, and ^ means to the Nth power.

For example, £65,000 principal balance with £16,250 in savings with .4167% monthly interest for 30 years results in a monthly payment of £261.7 (interest and principal).

Tip

Once you subtract the offset amount from the original principal, you can use any one of several online mortgage calculator resources to arrive at the same answer more quickly.

Warning

Interest will be calculated on the principal balance minus the amount in your auxiliary account. Therefore, if you add to or subtract from your auxiliary account, your monthly payments will vary accordingly. The auxiliary account held to offset the principal balance usually will not earn interest. However, since the interest due on the mortgage is typically much higher than the interest earned in a traditional savings account, the borrower often experiences a net benefit. For example, a savings account that earns 3 per cent interest, but offsets interest due at 5 per cent or higher, nets a 2-percent benefit to the borrower. Therefore, offset mortgages are more attractive for prudent savers.