When you have a home loan, you repay both the principal and the interest. Depending on the size of your loan, the interest payments can be substantial. An offset account can help reduce the amount of interest you owe while keeping your funds easily accessible.
With an offset account, you can perform everyday banking tasks like online transactions, debit card payments, and ATM withdrawals. You can even set up direct salary deposits into this account.
Here’s how an offset account works and some tips on how to use it effectively to maximise your savings.
How Do Offset Accounts Work?
An offset home loan integrates a regular mortgage with an offset account. Instead of earning interest on the funds in your offset account, the balance in this account is subtracted from your outstanding loan balance when calculating monthly interest.
For example, if you have a $300,000 loan and $10,000 in your offset account, interest is calculated on $290,000 instead of $300,000.
With an offset account, the interest charged on your loan is reduced because the balance in the offset account is subtracted from your loan balance when calculating interest. Although your monthly repayments stay the same (unless the interest rate changes), a larger portion of each payment goes towards reducing the principal of the loan rather than just covering the interest.
This shift in payment distribution means that, over time, you will make faster progress toward paying off your mortgage. By consistently using an offset account, you can potentially save thousands in interest payments and become mortgage-free sooner.
Which Is Better: An Offset Account or a Savings Account?
Having some money set aside for emergencies is important, but if you have a home loan, using an offset account can be a very effective way to maximise the value of your savings while keeping access to the funds.
An offset account can also offer tax advantages compared to a standard savings account. Interest earned in a regular savings account is taxable, which can significantly impact high-income earners.
With an offset account, you don’t pay interest on the money held in the account, and there are no tax implications for the funds within it. Instead, the money in your offset account reduces the balance of your home loan, which can help you pay off your mortgage faster.
For personalised advice on how an offset account could benefit you, consult with a qualified tax professional.
What Types of Offset Accounts Are There?
Offset accounts are normally associated with variable-rate home loans but can also be an account linked to some fixed-rate home loans.
There are usually two major types of offset accounts:
- 100% Offset Account: The entire balance of the offset account is deducted from your home loan balance when calculating interest. For example, if you have $20,000 in your offset account and your home loan balance is $200,000, the interest is calculated on $180,000 ($200,000 loan balance minus $20,000 in the offset account).
- Partial Offset Account: Only a portion of the offset account balance is used to reduce your home loan balance for interest calculations. For instance, if you have a $150,000 loan balance and $50,000 in the offset account with a 50% offset, interest is calculated on $125,000 of your loan balance.
While many lenders offer 100% offset accounts, it’s essential to check with your lender for their specific offerings.
Are offset accounts really worth it?
Offset accounts are not suitable for everyone. Many loans with offset accounts come with higher interest rates or additional fees. If you frequently have only a small balance in your offset account, you might end up paying more in interest than if you had a basic home loan with a lower rate and fewer fees.
How Much Can I Save with an Offset Account?
A large balance in your offset account can save you thousands of dollars in interest and potentially shorten your mortgage term by years. To estimate how much you could save with an offset account, you can use online calculators that show the potential impact on both interest payments and mortgage duration.
Example Savings with an Offset Account
The table below illustrates how much you might be able to save if you have an offset account facility of either $20,000 or $40,000 on a $500,000 home loan at an interest rate of 6.40%.
An offset account with $20,000 might mean long-term interest savings of around $102,411. Increasing it to $40,000 might increase your savings over the life of the loan to about $183,675 and also shorten the loan term.
Offset Account Interest Savings on a $500,000 Home Loan
AMOUNT IN OFFSET ACCOUNT | HOME LOAN INTEREST RATE | MONTHLY REPAYMENTS | TOTAL INTEREST PAID | TOTAL INTEREST SAVED | TIME TO REPAY |
0 | 6.40% | $3,128 | $625, 911 | – | 30 Years |
20,000 | 6.40% | $3,128 | $523, 500 | $102, 411 | 27 Years, 4 Months |
40,000 | 6.40% | $3,128 | $442, 235 | $183, 675 | 25 Years, 2 Months |
Source: www.canstar.com.au 14/06/2023
NOTE: The calculations are based on a 30-year loan term with the offset account balance the same for the term of the loan with 80% LVR and principal and interest repayments. The review excludes introductory offers and other special condition loans.
What Could Be the Possible Advantages and Disadvantages of an Offset Account?
The financial benefits that a mortgage offset account offers depend on two key factors::
- Interest rates and fees of other comparable loans which which may or may not have an offset facility
- How much money you actually intend to have in the offset account.
Considering these factors will help you understand how an offset account might benefit you financially.
Possible Advantages
Lower Interest on Your Home Loan
Maintaining funds in your offset account can substantially reduce the interest you pay on your home loan. This can lead to significant savings, potentially saving you thousands of dollars in interest and shortening your loan term by years. Even a small balance in a 100% offset account is beneficial, as every dollar in the account reduces the amount of interest you owe.
Maximise Savings
Typically, home loan interest rates are higher than the interest rates offered by savings accounts. This means that keeping your funds in an offset account usually provides more financial benefit compared to placing them in a traditional savings account. Additionally, the interest savings you gain from an offset account are not subject to tax, whereas the interest earned from a savings account is taxable.
Availability of Additional Funds
An offset account is a useful financial tool that allows you to keep your emergency funds accessible while also reducing the interest on your mortgage. By maintaining money in this account, you lower the amount of interest charged on your home loan. Additionally, if you face unexpected expenses or changes in your financial situation, such as a medical emergency, you can easily access and use the funds in your offset account.
Possible Disadvantages
Higher Fees
Loans with offset accounts often come with higher fees compared to basic loans that don’t have this feature.
Higher Interest Rates
The interest rates on loans with offset accounts may be higher than those on simpler loans with fewer features.
Effectiveness Depends on Account Balance
An offset account is most beneficial when you maintain a substantial balance. If you choose a loan with a higher interest rate and fees due to the offset account, you need to have enough money in the account to offset these additional costs. The effectiveness of the offset account depends on factors such as the loan amount, interest rate, and annual fees. It’s important to evaluate your long-term savings goals and the amount you can keep in the offset account compared to a traditional savings account.
Offset Account vs. Redraw: Which Is Better?
Offset accounts and redraw facilities are features that can be added to home loans, but they function differently. It’s important to determine which option best meets your needs.
In an offset account, you have instant access to your funds whenever you need them, providing immediate liquidity. This is different from a redraw facility, where accessing your funds requires a formal request. With a redraw facility, the funds may not be available the same day and are usually subject to minimum and maximum withdrawal limits.
You can deposit any extra savings into an offset account, which reduces the amount of interest you pay on your home loan. In contrast, with a redraw facility, you can only access the additional money you’ve paid beyond your regular monthly repayments. Essentially, you can only withdraw the extra funds you’ve put in, not the regular repayment amount.
Offset accounts usually have low or no account-keeping fees, but there might be some transaction fees. Redraw facilities, on the other hand, can have fees depending on your loan’s terms.
With offset accounts, money is readily accessible, which might lead to more spontaneous spending. In contrast, redraw facilities require you to request access to your extra payments, which can make it less tempting to withdraw funds impulsively and may help control unnecessary spending.
Offset Account vs. Redraw: The Best Choice
Choosing between an offset account and a redraw facility depends on your personal needs and spending habits. An offset account offers easy access to your savings, which can reduce the interest you pay on your mortgage and provide flexibility. On the other hand, a redraw facility controls access to extra payments, which can help prevent impulsive spending.
Ready to get the most out of your home loan features? We’ll work out options that make the most sense for your financial needs. Give us a call today for expert advice and tailored mortgage solutions!
