Many would have heard of interest offset loan in Singapore when it comes to mortgages. However, most either do not quite understand how it works, or have yet to fully appreciate the true benefits of having such a feature in their home loan.

What is a mortgage interest offset account?

Simply put, it is like a savings account which pays you the same mortgage rate as deposit interest, up to a certain percentage of the funds you deposit, for example 70%, which is in turn capped at no more than the current outstanding mortgage loan balance. Don’t worry if you’re somewhat lost as we will explain this with an illustration below.

You do not actually see the deposit interest earned in the account every month, as it is used to “offset” against the interest component in the monthly mortgage repayment, hence the name “interest offset mortgage account”. By reducing the interest component and increasing the principal repayment component every month, this reduces the loan balance much faster than otherwise.

There are three mortgage lenders which offer such interest offset feature and we like to introduce HSBC’s SmartMortgage in this article, which has one of the highest qualifying deposits ratio of 70%, amongst the three banks. The other two being StanChart at 67% (up to two-thirds of the funds deposited) and Citibank at 50%.

Let’s take it look at how it works by way of an example.  Assuming Mr. Tan just refinanced an outstanding loan of $700,000, 25-year tenure to a HSBC floating rate package which comes with the SmartMortgage account (interest offset is only available to floating rate packages and not fixed rate). The table below illustrates the effect of interest offset when Mr. Tan deposits $200,000, $700,000 (equivalent to his loan) and $1,000,000 into his SmartMortgage current account.

Notice how the interest earned on the qualifying deposits is now used to “offset’ against the interest component in the monthly repayment so that more of it goes towards reducing the principal loan.  Mr. Tan still pays the same mortgage repayment amount of $2,967 every month across all scenarios.

In scenario A where there is no interest offset current account, he would be paying approximately 40% of that monthly repayment as interest to the bank.

In scenario B when he deposits $200,000 of his idle funds into his SmartMortgage account, he reduces this interest costs by 20% from $1,167 to $933 which has the same effect of reducing his mortgage interest rate by 20% from 2% to 1.6%.

What happens if Mr. Tan deposits the equivalent amount to his loan of $700,000 idle funds into SmartMortgage?  That would be scenario C where his interest component is further reduced to $349 which effectively means he is paying only 0.60% on his home loan.

In the last scenario D when Mr. Tan deposits $1m idle funds into SmartMortgage, his mortgage interest offset remains the same as the bank has capped the maximum offset at 70% of the outstanding loan, ie. $490,000.

Now you might wonder why would someone with idle funds of $700,000 still need to take out a home loan of $700,000?  That’s entirely possible depending on your objective.  To answer that, let’s look at some benefits of an interest offset mortgage loan with HSBC’s SmartMortgage:

1. Reducing the loan without actually doing repayment

Most of us will not have so much idle funds as to do a scenario C above where you effectively pay down the loan in full, i.e. you don’t really need to take out a mortgage loan in the first place. Yet, you do that for liquidity reasons which I will discuss in the next point.

Many of us, though, would have some kind of funds stashed away for emergencies or rainy days in life. This could be 6x or 12x of your monthly income which could easily be $50,000 to $100,000 or more.

These funds are strictly not for investment and must be kept liquid for easy access anytime. You could hunt around for the highest savings account deposit interest rate in town but we all know, with a falling interest rate, you get peanuts no matter where you look. You could look for high-yielding savings account which requires you to complete certain tasks or meet certain transaction values every month.

Alternatively, you could simply park your spare cash into an interest offset mortgage account which is like “paying down the loan without actually repaying”. An interest offset account has the same effect as temporary repayment on your outstanding loan as you are paying less interest every month. Yet, those funds remain fully accessible to you should you need to withdraw them anytime.

Contrast this with actual repayment on your mortgage loan to save on interests. It will not just cost money to take back the loan later in the form of a home equity loan (for private properties only), it will cost you much time and trouble not to mention some might find that they are unable to do so (if much CPF has been used towards the property)!

2. Access to liquidity at minimal cost

Another group of homeowners might have all the funds to fully redeem and discharge a mortgage loan, but is this a wise move especially if you are depleting all your liquid funds on hand?

For high net worth individuals or seasoned investors, this access to liquidity is highly-valued when even a day’s delay could make or break a deal, or cause one to pass up on an opportunity like steep stock market draw downs, distressed property fire sale, etc.

As the saying goes when it comes to investment, always keep some dry powder. Accessing your “ready funds” when the opportunity arises is as easy as withdrawal money from your savings account!

For others, parking their funds in an interest offset account could offer the liquidity to start a business or make unexpected career moves in life like a relocation, at the flip of a coin.

To balance things up, this access to liquidity does come with some minimal costs.  In scenario C above, Mr. Tan parks $490,000 in SmartMortgage account and is thus effectively “prepaying” $490,000 of the loan. However, he still services an interest of 2% p.a. on $210,000 (or effectively 0.60% p.a. on the entire $700,000). If Mr. Tan actually has $700,000 to fully discharge the loan, this is the small costs he pays to keep that access to liquidity. In actual fact, this cost is much smaller than 2% as he would be earning risk-free return on the same $210,000 which is no longer needed for full redemption of the loan.

3. No loading of interest rate with SmartMortgage

Another good thing about HSBC’s SmartMortgage account is that there’s no additional loading in interest spreads on the mortgage loan when you opt for it.

Some banks might add a 0.1% loading on spreads on top of the usual floating rate offered, when the mortgage loan applied for comes with an interest offset account. For example, instead of 3-month SORA + 0.35% in the first year, your rate might be 3-month SORA + 0.45% if you ask for an interest offset account,

4. Added assurance when betting on floating over fixed mortgage rate

With uncertainties still running high in the midst of tariffs, trade war and a changing world order, it is becoming harder for homeowners to choose between signing up to a fixed or a floating home loan rate.

An interest offset account becomes a very useful mitigating tool in such a predicament.  While you might want to bet on a floating mortgage rate over a fixed rate to save on interests going forward, you don’t have to lose total control should the opposite scenario materialises and interest rate unexpectedly heads north!

The risk is somewhat mitigated by quickly parking idle funds into a SmartMorgtgage account like what we have seen in scenario B above. By depositing $200,000, it reduces the interest cost to $933 right from the first instalment which would be akin to you paying 20% less in interest, only 1.60% instead of 2%. This helps mitigates the cost as you buy yourself more time to exit the lock-in period when the bet on floating goes wrong.

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