What Is a Home Loan Offset Account and How Does It Work?
An offset account could help save money on your mortgage and reduce the amount of interest you pay. You might even pay off your home loan sooner. But, how does it work? Is an offset account right for you? This article will explain what it is, how an offset account works, and how to get the most from yours.
What Is an Offset Account?
Essentially, an offset account is a transaction account that is linked to your home loan. You can use it as you use any everyday transaction account. You can make deposits or withdraw money as and when you like.
However, the main feature of offset accounts is that when you leave money in your account for some time, it reduces the amount of interest you pay on your home loan. The funds held in your account are offset against the home loan.
The more money in your offset account and the longer it is in there, the less interest you’re charged. With less interest, you can pay off your home loan balance sooner.
Typically, you can only get an offset account on a variable rate home loan. However, speak to your broker about lenders offering offset accounts on fixed-rate home loans.
Although, you should also be aware that some home loans offer appealing looking offset accounts but with other additional fees or higher interest rates.
How Does It Work?
Offset accounts are appealing options for home buyers. The linked savings account doesn’t earn interest throughout the life of your loan, as any interest savings are used to offset the interest accruing on your mortgage. Therefore, you end up paying the home loan balance minus the interest on your offset account.
You might think that you can earn more interest elsewhere in a regular savings account. However, most savings accounts typically have lower interest rates than an offset account. For example, the average savings account interest rate might be around 1-3%. An offset account could have an interest rate as high as the mortgage interest rate you’re charged.
While you don’t have access to the interest, like you would on a standard savings account, this is used to make non-taxable payments towards your mortgage. It can help you reduce the overall lifetime of the loan and potentially save you thousands.
Let’s take a look at an example. Say you have a mortgage of $400,000 with an interest rate of 3% over a loan term of 30 years. Without the offset account, you would have to pay $207,110 in interest over 30 years. However, making monthly deposits of just $200 into a full offset account could reduce your loan term by two years and two months and save you $11,167.72 in mortgage interest.
After the loan term is up, you will have access to your savings. Or, you can withdraw your savings at any point throughout the loan. However, this would have less of an impact on reducing your interest payments. To make the most of your offset account, keep the money in there as long as possible.
Advantages of an Offset Account
There are many advantages to offset accounts. These include:
- Reducing the life of your loan
By depositing money in your offset account, as you would with an everyday bank account, you might shave years off your home loan. You don’t even need masses of spare savings in your linked transaction account. Even just a few extra dollars each month could save on interest on your home loan.
As home loan interest costs are calculated daily, keeping funds in your account for a short period can still mean significant savings.
The more of the principal balance you pay off, the less interest accrues, and therefore, the loan is paid off sooner.
- Reducing interest repayments
While a mortgage offset account doesn’t typically reduce the monthly loan repayments, you can use it to reduce the interest on your home loan. Over the loan’s entire life, you can minimise the interest you pay.
- Make more on your savings
As mentioned, your home loan interest rates will be higher than the interest on savings accounts or a regular transaction account. Even a partial offset account compared to an everyday account would make your savings work harder for you. Plus, you are not charged tax on interest saved in an offset account, but you are usually in other savings accounts.
- Keep extra funds accessible
Many savings accounts limit your ability to access your savings regularly. Plus, if you use your additional funds to make extra repayments on your mortgage, it can be hard to access the money should your financial situation change. With an offset account, you can usually access extra repayments should you need to.
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Disadvantages of an Offset Account
Although, as with all good things, there are some drawbacks to using an offset account over a normal transaction account.
- Potentially higher fees
While an offset account could help you reduce your mortgage repayments, you might find that a home loan with an offset feature actually comes with higher fees. Make sure you speak to your mortgage broker and look at the comparison rate to understand the loan’s actual cost so you don’t find yourself losing money.
- Potentially higher interest rate
Additionally, you might pay interest at a higher rate on a home loan account offset feature. This means that while you’re saving on paying interest, you’re having to put more savings into your account to enjoy this feature.
Look at other home loans to see if the charged interest rate is lower and whether this might work better for your financial situation (e.g. you’re less likely to make extra repayments and want to keep your monthly repayments low).
- A large deposit
In some cases, for the offset account to be effective (and worthwhile against the additional fees mentioned above), you must deposit large sums of money into the offset account. While you can withdraw your funds at any time, it might be to your disadvantage.
- Financial discipline
Finally, a certain level of financial discipline is required not to keep withdrawing your money in the offset account.
Types of Offsets
There are different types of offset accounts you should know about. The two primary types are 100% and partial accounts.
100% Offset Account
The 100% offset account, also known as a ‘full’ offset account, is where the interest payable is linked to the account’s total balance. You can typically get a 100% offset account on either fixed or variable rate home loans. The entire interest that you accrue on the money held in the offset account is used to reduce the interest you pay on your home loan each month.
Therefore, the monthly repayments make more of a dent on the principle of the loan balance.
Partial Offset Account
On the other hand, a partial offset account only offsets your home loan by part of the offset account balance. The interest that you accrue on the account balance is lower than the interest charged on your loan. For instance, the home loan interest rate is 4%, but the offset account interest rate is only 2%. You’re still saving money, but not as much as with a 100% offset account.
You can get different rates of partial offset accounts. The higher the percentage of the portion, the more money you save. Generally speaking, the partial offset account is often for a fixed rate home loan.
Who Can Get an Offset Account?
Usually, anyone with a variable interest rate loan can get an offset account. Some fixed-rate home loans also come with partial or full offset accounts. Speak to your mortgage broker about which credit provider will offer you an offset account and whether you will qualify for their lending requirements.
There are no rules against expats applying for offset accounts, either. Odin Mortgage will offer you expert advice about how to apply for an offset account on your mortgage.
How to Use an Offset Account
There are many ways to use your offset account. You might want to deposit your salary straight into the account and use it as a regular transaction account. Or you might choose to treat it as a savings account for depositing more considerable sums of money for holidays or renovations. You might even use your offset account as a place to set aside money for your tax bill.
As long as your offset account balance is regularly topped up, it doesn’t matter how much money is deposited or where it comes from.
How Do I Get the Most From My Offset Account?
So, you’ve heard us mention that you could save thousands – even tens of thousands – and shave years off your mortgage, but how? Below we’ve listed some tips to make the most of your offset account.
- Deposit your salary
As mentioned earlier, some people use their offset account as a transaction account. By depositing your monthly wages into your offset account, you’ll keep it regularly topped up. There will always be a dollar in your account to offset against your home loan interest repayments.
- Deposit all your extra money
If you have another savings account with a lower interest rate, it might be more sensible to pool your extra money into your offset account. This is especially beneficial if you have many savings or regular transaction accounts.
- Use a credit card
As you don’t have to pay a credit card off until the due date, you can leave your funds sitting in your offset account, earning you interest off your home loan. Rather than paying for your items as you buy them, you can allow your money to accrue interest for an extra four weeks until you need to pay off your credit card.
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The Effects of Withdrawing From an Offset Account
Ideally, you want to hold a minimum balance in your offset account at all times; otherwise, you risk not enjoying its full potential. While there usually aren’t fees associated with withdrawing from an offset account, your mortgage will last longer than if you keep a more significant sum of money in your account.
For example, if you usually held $50,000 in your offset account, you would only pay interest on $300,000 of a $350,000 mortgage. However, if you then withdrew $25,000 to pay for a new expense (e.g. a renovation), you will now have to pay interest on $325,000.
While this is arguably still a better situation than if you had less than $25,000 in the account or no offset feature, remember that your home loan might be subject to higher fees.
Therefore, you should always make sure that you have enough money in the account to offset the additional fees or higher interest rate before you withdraw.
Offset Account Vs Normal Savings Account
As we’ve covered, your home loan interest rate is generally at a higher interest rate than typical savings accounts. Therefore, it’s usually considered more financially savvy to use an offset account to deposit your savings.
In addition, the tax benefits that come from an offset account are not generally applied to other savings accounts.
What's the Difference Between Offset and Redraw Facility?
A redraw facility is similar to an offset account. With a home loan, after a few months or years of paying off your mortgage, you might want to make extra home loan repayments to pay off your loan sooner. You could either raise the regular repayments or make one-off additional payments.
However, later in your life, you might need extra cash for any number of reasons. With a redraw facility, you can take back any extra repayments, should you wish to do so.
For example, if you have to pay a minimum monthly repayment of $1,000, and you pay an extra $100 a month, you will have an additional $1,200 to withdraw at a later date.
Generally speaking, it is relatively easy to redraw your money. Each lender will have different options about how to go about it – talk to your mortgage broker about whether you can have a redraw facility on your home loan. Additionally, there is no minimum amount to withdraw. The maximum is the amount of extra payments you have made.
While offset accounts and redraw facilities sound similar, and both have the potential to save you interest, there are several differences. An offset is an account like a bank account, while a redraw facility isn’t an account but an additional feature that allows you to access your money.
Is It Better to Pay Off Your Home Loan or Offset It?
Whether you make extra repayments to pay it off or use an offset account to reduce interest payments, both approaches have their merits.
If you make larger additional payments for a long time, then you will pay your loan off far sooner and enjoy reduced payments in the final years of the loan’s life. Use our mortgage repayment calculator to determine how much you can afford to pay.
This might be a suitable approach if you have a higher disposable income. Plus, you have the flexibility to revert to paying the minimum amount if ever you find yourself with less cash. However, unless you have a redraw facility, those extra payments are not accessible. Even if you do have a redraw facility, withdrawing the money will increase the amount you pay on your home loan.
On the other hand, an offset account might be a preferred approach if you don’t have significant disposable income.
Is an Offset Account Right for You?
We all have different situations. Before you settle on a mortgage with an offset account, consider the pros and cons, and speak to one of our expert brokers about your circumstances.
If you want to cut years off of your home loan but retain access to the money, then it might be for you. However, remember to consider any additional fees you are charged for the facility. Is the amount of interest you save likely to be higher than the fee?
What Are Some Other Ways I Can Save Money on My Home Loan?
If an offset account or redraw facility doesn’t sound like they would be promising approaches for you, don’t worry; there are other ways you can save money on your mortgage. Even if you’re considering applying for an offset account, these different ideas are worth weighing up.
- Negotiate lower interest rates
Shop around or ask your mortgage broker to find a loan with low-interest rates. A substantial deposit and clear credit history will often improve your borrowing power to negotiate lower interest rates. Also, remember to look at comparison rates for the true cost of the loan.
If you’re already paying towards your home loan, consider refinancing to find a deal with lower interest rates. If you’re able, maintain the same monthly repayments with your new loan to help you repay it faster and save on interest.
- Pay fortnightly
Paying fortnightly is often considered a more innovative way to repay your loan than making monthly repayments. As there are 26 fortnights in a year, but only 12 months, you essentially pay an extra month each year. However, the lender might calculate your repayments differently, so check with them before changing to fortnightly repayments.
However you choose to repay your home loan, speak to your mortgage broker about the best way for you to save. An offset account is often a promising approach for many home buyers. Yet, as everyone’s situation is different, you must seek professional advice about making an offset account work for you.
Get a free Australian mortgage assessment today.
Frequently Asked Questions
Does an Offset Account Reduce Monthly Repayments?
Your monthly repayments typically stay the same; however, your overall repayment amount will be less. You will be able to repay your mortgage faster as the offset account reduces the amount of interest you pay. Therefore, your monthly repayments will pay off more of the principal.
Does Fixed Home Loan Have Offset Account?
Depending on the lender, you may be able to get a partial or full offset account on your fixed-rate home loan. However, they are usually less common than they are with variable-rate loans. Although, after the initial loan period, it will shift to a variable rate, and you will be able to apply for an offset account then.
Is There a Limit to an Offset Account?
There is no maximum amount you can put into an offset account. However, it’s generally recommended that you put no less than $10,000 into your offset account for it to be worthwhile.
What Is the Benefit of Having an Offset Account?
You can potentially save thousands of dollars on your home loan interest with an offset account while reducing the loan term. The offset account balance is deducted from the loan amount that you are charged interest on.
Is It Better to Have Money in Redraw or Offset?
An offset account enables you to reduce the interest payable on your home loan and pay off the loan sooner. A redraw facility allows you to make extra repayments (also shaving years off the loan term) that you can take back should you need. Both help you pay off your loan faster, but the former is typically better suited for those with higher amounts of disposable income.