Offset Account: The Definitive Guide to Lower Your Interest Payment
Whether you’re about to take on a new home loan or have an existing one, there are lots of clever ways to reduce the total amount you pay and decrease the lifespan of your loan.
One strategic way to potentially bring down the balance of your loan and pay it off faster could be by switching your everyday bank account to an offset account.
Read on to learn more about offset accounts.
What Is An Offset Account?
An offset account is linked to a home loan and works like any transaction account that you use to deposit and withdraw money on a day to day basis.
If you start an offset account while taking a home loan, you do not have to pay interest for the full loan amount. Interest will only be charged for the amount you get after subtracting the amount deposited in the offset account from the loan amount. The higher the balance in the offset and the longer the duration it sits in there, the less you will have to pay (ie: if you withdraw the amount you deposit in the offset account quickly, you cannot save much).
In most cases, the offset feature is only available on variable rate mortgage loans, although there are some lenders that do offer an offset through a fixed loan.
How Does An Offset Account Work?
Here’s an example to help break things down for you:
Suppose you take a home loan of $300,000 from your bank and start an offset account with $10,000 deposited into it.
If you do not have an offset account, interest would be charged for the full loan amount (i.e $300,000). However, in this case, interest will be charged on $290,000.
The balance in the offset account is subtracted from the loan amount to obtain the sum of money for which interest will be charged. This will continue as long as the amount you deposited in the offset account stays in it.
While you do not make money with offset accounts, your money is still working for you (your expense is reduced!). The idea of an offset account would be to reduce the amount of borrowed cash, which you are repaying interest to shorten the period of your loan.
Should I get an offset account?
It really depends on your situation and the best thing to do would be to weigh the pros and cons of an offset account before you make the final call.
Here are the advantages of having an offset account:
The balance in your offset account can be accessed any time you wish. Lenders tend not to penalise you for withdrawing money from the offset account. The accessibility ensures that an offset account is nothing short of a conventional savings account (Make sure you don’t have to pay a fee for withdrawing from the offset account).
The major purpose of an offset account is to reduce the interest on home loans. Keeping a considerable amount in your offset account for some time will help you save interest charged on your home loan.
A savings account is a good source of income if you have a high income to start off with. However, almost all the time, the amount you earn on a savings account will be much less when compared to the interest you can save on home loans. This explains why switching to an offset account is often more attractive than sticking with a regular savings account.
Here are the disadvantages of having offset accounts:
If you deposit a sum into your offset account and withdraw it quickly, maintaining one will not be of much use to you.
Opening and maintaining an offset account does not come without a cost. Lenders often charge an annual package fee or a monthly fee for the offset account and the amount of interest you are likely to save could be lower when compared to the fees (we would crunch the numbers for you). If you are unable to retain a certain amount of money in your account, you could hardly get any benefit out of it.
*Note: Small changes in the balance will not matter much because interest is calculated daily.
In some cases, the offset accounts are linked to home loans with higher interest rates, which means you will have to maintain a considerably higher balance in the offset account to compensate for the loss brought by the high-interest rate.
What Are The Different Types Of Offset?
There are two types of offset accounts:
– 100% offset
When you start a 100% offset account, the interest you earn is equivalent to the interest you save. Most Aussie lenders offer 100% offset accounts.
– Partial offset
In the case of a partial offset account, only a portion of the balance in the offset account will be used to offset the interest charged on the home loan. (eg: Bankwest currently offers a 40% offset against the fixed rate.)
Offset Accounts VS Savings Account
Your cash works harder in an offset account in comparison to an everyday savings account as the interest rate on a home loan is higher than that of a savings account.
Another advantage is the interest you save yourself with an offset account will not be looked at as income (rather, expense reduced) – this means the saved amount could not be taxed. On the flip side, the interest you earn on a savings account will be considered as income, which means it is taxable.
Offset Account Vs Redraw Facility
Let us make a comparison between putting money in offset accounts and putting it in a redraw facility.
Simply put, a redraw facility is a feature attached to your home loan that allows you to access extra repayments that you have made on the loan while an offset account is a transaction account.
A redraw facility may not be as flexible as an offset account and you would not be able to redraw money from the ATM or make transactions with your bank card. Some lenders also set minimum redraw amounts.
There would also be different tax implications, whether you decide to rent out your home, live in the property or treat it as an investment.
If you decide to rent out your home as an investment property, the interest charged on the loan may be tax deductible, but if you redraw from your redraw facility for non-investment purposes, that amount would not be deductible.
However, if you are on an owner-occupied loan and decide to redraw for investment purposes, you would be able to claim mortgage interest expense on the amount that you have redrawn for investment purposes.
On the other hand, withdrawing amounts from your offset account won’t affect the tax deductibility of interest charged on your loan.
If there is a possibility that your first home could one day become an investment property, we suggest you talk to us for advice on the best way to reduce interest on your loan by using a redraw or offset account. (You might even be better off with both!)
What Is The Best Way To Use an Offset Account?
Some individuals have their salary transferred directly into their offset accounts and use it as an everyday transaction account while others use their offset as a checking account for things such as vacations, refurbishments, or for less fascinating purposes like saving cash for tax bills.
Here are some things you can do to make the most out of your offset account.
- Deposit your savings into the offset account
- Deposit your salary in the offset account
- Consider combining your offset with your credit card payments (you could use a credit card to take care of your expenses during the interest-free payment period but once it is due, pay the full balance because your credit card interest will be much higher when compared to your home loan interest)
As good as some features sound, don’t expect all offset accounts to be the same. Check every detail before you start an offset account so that you can maximise your savings.
Need help deciding whether you are better off with an offset?
Our expert team is here to help you navigate the maze of options. With access to a multitude of products, we are able to choose the best to suit your needs.