You’ve learned about what you need to secure a mortgage , now it’s time to think about how you will manage said mortgage.
An offset account is one option to consider, it reduces the amount of interest charged to your loan. This can lead to thousands of dollars in savings and help you pay off your loan sooner.
In this article we explain mortgage offset accounts in plain English and detail the benefits and potential issues associated with linking an offset account to your home loan. This backgrounder will equip you to do further research on the subject without wanting to tear your hair out (consequently half our team happens to be bald now…). So without further ado, let’s dive in.
What is a mortgage offset account?
An offset account is a standard transaction or savings account (a.k.a an everyday bank account) linked to your home loan. This connection is beneficial because the sum in your offset account serves to minimise the amount of interest charged to your loan.
How does this work? An offset account is linked to your mortgage and thus your lender will consider both sums when calculating interest. The formula for a 100% offset account would be: mortgage sum minus offset sum equals the amount you pay interest on. So if you had a $500,000 mortgage but had $50,000 in your offset account then you would only pay interest on $450,000. By paying less interest your payments make a bigger dent in your principle loan (the sum of money you borrowed in the first place), meaning you can pay off your mortgage more quickly.
Head still reeling?
Think of it as negative versus positive or, to embellish things, good versus evil. The interest accrued on a home loan is a negative, a villain. An offset account is a positive, a hero. As long as the hero is in play, the power of the villain is lessened. Like Superman and Lex Luthor. As long as Superman is around, Lex’s evil plots will never reach their full magnitude. As long as you have an offset account you will never have to pay full interest on your loan. There are caveats to consider however, and so please do read on before you run off and play good and evil with your finances.
What are some important considerations to make regarding mortgage offset accounts?
There are pertinent issues to consider when contemplating mortgage offset accounts.
First, not all offset accounts are created equal. It is important to do your research and pay attention to the fine print. For instance, some options only offer a 50% offset meaning your savings will only do half as much when balancing interest. Certain offset accounts include an additional fee and others even charge added interest. Even an added interest of 0.11% can lead to thousands of extra dollars paid.
Second, persons can opt to have their salary paid directly into their offset account, thus maintaining a healthy balance. Not all employers can pay your salary directly into an offset account and so make sure you confirm this before building a savings strategy around this method.
Third, offset accounts can usually only be linked to home loans on variable rates. If you have a fixed rate home loan you might not be able to take advantage of this option.
When making a decision, consider the rates being offered as well as the lump sum you may immediately want to include in an offset account. Additionally, think about how much money you would plan to keep in your offset account at all times. These variables can all impact the effectiveness of an offset account. It is well worth taking the time to do the math before making a decision. It’s also prudent to consider alternate options.
Offset Account vs Savings Account
What is the difference between an offset account and a savings account?
A savings account is a deposit account that earns interest. An offset account can function like a savings account but it is also linked to your home loan.
If you have some money saved up, there can be an advantage to holding it in an offset account instead of a regular savings account.
Savings accounts attract higher interest rates but they usually pale in comparison to the rates attached to home loans. The interest accrued from a savings account could not offset the interest charged on a home loan.
The money kept in an offset account is tax-free where you automatically have to pay the tax on any interest that you earn from your savings account.
Offset Account vs Direct Loan Repayments With Redraw Facilities
Depending on the terms on your loan, you might be able to make additional direct loan repayments over the life of your loan. Direct loan repayments mean you can make extra payments to your loan which go directly toward your principal, bypassing interest. Most loans with direct payment options offer redraw facilities. If you ever need extra cash, you can redraw money from the direct repayments you have made. Usually there are limits on withdrawals and fees associated.
You can withdraw money from an offset account as easily as you can with an everyday transaction account. Therefore if circumstances change, it’s much easier to access your money.
Both offset accounts and direct repayment options are great ways to get ahead on your mortgage. Deciding between the two would depend on your own financial situation and specific mortgage requirements.
Tips for maximising an offset account
Here are a two ways you can get even more out of your offset account.
1. Use a credit card
You can pay for a majority of your living expenses using a credit card (and repay it within the interest-free period) and keep your own funds in your offset account. Powerfully reducing your daily interest balance.
2. Debt recycling
If you want to invest the money held in an offset account consider debt recycling. Debt recycling allows you to turn non-deductible debt into tax-deductible debt and it could be a strategy that helps you pay off your home loan sooner while establishing a new investment. You can read about debt recycling in further detail here and here.
Where do we go from here?
By this point you should have a basic idea of what offset accounts are and how they compare to other options available to you. It’s time to continue your research, solo. Go now, be free!
Joking. We haven’t left you high and dry friends. Have a look our Resource List below for next steps.
- What is a mortgage offset account and how do they work? via Canstar.
- Use the MoneySmart Mortgage Calculator by the Australian Securities and Investment Commission.
- Talk to a mortgage broker about your options.
Connect with one of our financial experts to learn how you can get the most out of your money
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