Offset accounts let you save on mortgage interest and reduce the time it takes to pay off a home loan. If you know how to use one properly, you’re potentially saving thousands in interest payments as well as shaving years off your mortgage term.
Not everyone knows how to use one, so we’ll be covering the following throughout this article:
- How they work.
- The benefits.
- Potential drawbacks.
- Practical tips for getting the most out of them.
What is an Offset Account?
An offset account is a type of bank account that’s linked to your home loan – helping reduce the interest you pay on your mortgage. It functions like a regular transaction account, allowing you to:
- Deposit.
- Withdraw.
- Manage your money as you would with any standard account.
The difference is that the balance in your offset account “offsets” the balance on your mortgage. This reduces the overall interest you’re charged throughout the life of the loan.
For instance, if you have a home loan balance of AUD 400,000 and AUD 50,000 in your offset account, you’ll only be charged interest on AUD 350,000 (which is the difference between the two).
This means the more you’ve got in your offset account, the less you’ll pay in interest over the course of your mortgage.
How Does an Offset Account Save You Money?
You save money with these accounts by reducing your interest payments – interest is calculated daily on most variable home loans, meaning every dollar in your offset account lowers the principal on which your daily interest is calculated.
This is a basic example of what that looks like:
- Mortgage balance: AUD 400,000
- Offset balance: AUD 50,000
- Interest rate: 3.5% per annum
You’ll pay interest on the full AUD 400,000 without an offset account, whereas with an AUD 50,000 offset, you only pay interest on AUD 350,000. Since you’re not paying interest on that AUD 50,000, you can end up making significant savings over time. Put all that saved money into additional repayments, and you get even closer to reducing the length and cost of your mortgage.
Types of Offset Accounts
There are two types of offset accounts you can use in Australia:
100% Offset Account
A full or 100% offset account lets the entire balance offset your mortgage, meaning every dollar in that account directly reduces the amount on which interest is calculated. Most people use this one because you’re getting the most benefit.
Partial Offset Account
Some lenders might only offer partial offset accounts, which is where only a portion of the account balance offsets the mortgage.
For example, if it’s a 40% offset account, only AUD 40 out of every AUD 100 in the account reduces your mortgage balance. As you can see, this makes it a far less efficient account than the 100% offset ones, but obviously, you’re still getting some interest savings, so it’s better than nothing.
Offset Accounts vs. Redraw Facilities: Key Differences
Offset accounts get compared to redraw facilities fairly often since they’re both offered by Aussie lenders – both of them reduce interest, but they function completely differently:
Offset Account
These act like separate transaction accounts where you can access your funds without any sort of restriction. You can deposit and withdraw as much as you want, all while your balance is directly offsetting your mortgage.
Redraw Facility
This lets you make extra payments directly into your mortgage, thus reducing the principal. If you absolutely need to, you can still withdraw the extra payments, but there might be some limitations or fees associated – it depends on your lender.
The main difference here is that offset accounts keep your funds separate from your mortgage balance, which makes it far more flexible. That’s not the case with redraws since your funds are applied directly to the loan – some borrowers like this, but it might restrict access if you’d prefer more liquidity.
Key Benefits of an Offset Account
People with variable-rate home loans seem to get the most out of offset accounts. That said, there are plenty of benefits anyone can access:
Reduced Interest Payments
You lower the interest charged on your loan by offsetting the principal. This ends up saving potentially thousands over the life of your loan.
Faster Mortgage Repayment
Reducing the interest component means more of your regular repayments go toward the principal, which helps you pay off your loan sooner.
Tax-Free Savings
The funds in an offset account don’t earn taxable interest as you would with an ordinary savings account. This means the money saved on interest is effectively tax-free, making it highly effective for high-income earners.
Easier Financial Management
With an offset account, you keep the following in one place so that your finances are simplified:
- Income.
- Savings.
- Daily spending.
The closer you keep this balance to your target amount, the more interest you’ll save
Potential Drawbacks of an Offset Account
We’ve only talked positively about offset accounts thus far, but there are still a few downsides worth considering:
Fees and Charges
It’s not uncommon for offset accounts to come with account-keeping fees or even higher interest rates on the home loan itself. This defeats the purpose a bit since it ends up offsetting your savings. Make sure you check the fee structure to ensure it won’t negate your interest savings.
Interest Rate Considerations
Offset accounts are usually tied to variable-rate loans, which means your interest rate can fluctuate over time. While interest rate cuts can reduce your payments, rate increases may raise them, which will affect your budget.
Who Benefits Most from an Offset Account?
Anyone who can keep a significant balance in the offset account is going to see the most benefits – these people are usually homeowners with substantial savings. That said, there are other people who can get a lot out of offset accounts:
High-Income Earners
If you have a steady, high income that lets you build up savings regularly, an offset account can help you make your income work even harder by reducing mortgage interest.
Self-Employed Individuals
For those who might have more irregular income, an offset account still offers good flexibility. This is because you can deposit larger amounts when business is good, but still be able to withdraw whenever you need to.
Families with Savings Goals
An offset account can be a quality tool if you’re saving up for future expenses but still want to reduce your mortgage income. This could include:
- Holidays.
- Renovations.
- Children’s education.
Investors
Since the interest saved is effectively tax-free, an offset account is particularly beneficial for investors who are in higher tax brackets as they maximise your tax efficiency.
Conclusion
Remember, if you want to get the most out of your offset account, you should be depositing your paychecks into the account. This lets you maximise interest savings from day one – every day you have funds sitting in your account, they’re reducing the interest you pay.
If you’re interested in using an offset account, your best bet is to speak with a mortgage lender to see how it can fit into your overall strategy. To find the best mortgage lenders, use Upscore’s Finance Passport! Get the best mortgage deals across borders and start your journey with Upscore today.
