Are you looking for strategies to reduce the interest paid on your mortgage? Have you heard about offset accounts that link to a home loan? Ever wondered what that means? When you are looking to pay off your mortgage quicker, one of the clever ways you can do this is by using an offset account.
This is a strategic way to reduce the interest you pay and can reduce the term of your loan. So how does an offset account work?
What is an Offset Account?
A home loan with an offset account can be beneficial. This is an account your lender links to your mortgage that you can use as a general everyday account. Deposit money into and use it to pay for your shopping. Even link a debit card to it for convenience.
An offset account reduces the interest you pay as the balance in the account offsets how much you owe. But you still have access to your money. For example, if you owe $300,000 on your mortgage and have $20,000 in an offset account, you only pay interest on $280,000, which means you pay of more of the principal each month.
Lenders can offer 100% or partial mortgage offset accounts. While they are usually linked to variable interest rate mortgages, some lenders will allow an offset account on a fixed rate home loan.
How Does it Help Reduce Interest Rates?
It is difficult navigating the world of home loans. There are so many that offer different features. Some are no frills loans and others may cost you more in the long run.
You need to decide which loan is right for you. No matter how you look at it, a mortgage offset account can save you paying a significant amount of interest over the life of the loan.
You may be wondering, is an offset account worth it? A hypothetical example: over the term of 30 years on a $400,000 mortgage could save you $31,674.18 in interest payments. This example assumes that you put $20,000 into the offset account from the beginning and make no withdrawals or extra deposits in that time.
You can potentially save more if you regularly deposit money into the offset account. On the other hand, what you save reduces when you spend the money in the account.
Check out what you can save using our offset account calculator.
Advantages of an Offset Account
The obvious benefit of an offset account is reducing how much interest you pay. Other benefits include:
- Tax free. Any money in your offset account is not taxable income as it does not earn interest. This is a bonus especially when you have large amounts of money sitting in the account to offset the interest on your mortgage.
- No fees or charges. An offset account generally has no fees or charges. You can deposit and withdraw as much money as you like whenever it suits you. There are no restrictions.
- Add any extra income. A great way to build up the amount in your offset account is to add any extra income you receive. This can include an inheritance, work bonuses and any profits from investments. While it will not earn interest, it all helps reduce the interest paid on your mortgage. Also you can access that money at any time you need it without your lender charging you fees.
Disadvantages of an Offset Account
Even though there are advantages, there are disadvantages. Offset account disadvantages include:
- Can cost more. Mortgages with an offset facility can cost more than other home loans. The interest may be higher, and the lender may charge monthly or yearly fees.
- Locks you into a variable rate. The majority of offset accounts come with variable interest rate loans. This can lock you out of switching to a fixed term interest rate during the term of your mortgage.
- Saving is essential. You need to be able to save to benefit from an offset account. If you have trouble paying your mortgage repayments or rarely have cash to spare, an offset account can cost you more. You may be better off with a standard home loan without any features. It will cost you less.
Does Offset Account Reduce Monthly Repayments?
Generally, the answer is no. This is not the purpose of an offset account. Your monthly repayments will stay the same. But because you reduce the amount of overall interest paid, you can pay the loan off sooner. Depending on how much money you have in the account, you could reduce the loan term by years.
Using an Offset Account to your Advantage
When you have a home loan with an offset account, you need to use it to your advantage. Here are three ways you can make the most out of it:
- Have your wage directly deposited into your offset account. Lenders calculate the interest on your mortgage daily, so have your employer deposit your wage directly into your mortgage offset account. Every single dollar deposited works to reduce the interest you pay, every day.
- Use your offset account as a normal bank account. Signing up for a home loan with an offset account means you can ditch your regular bank account. You might as well use it daily as every dollar counts towards paying less interest. Check with your lender, but you may be able to set up more than one offset account and use each one for different reasons. For example, use one for everyday spending and another for savings.
- Put everyday expenses on your credit card. Use your credit card for everyday expenses and pay it out at the end of each month from your offset account. Interest is calculated daily so using your credit card this way means you have more in the offset account for the month. Just do not forget to pay your credit card by the due date, or the interest you pay and any late charges will cancel out any interest you save on your mortgage.
Different Types of Offset Accounts
Many lenders offer offset accounts on their mortgage products and there are two different types:
- Partial offset accounts.
- 100% offset accounts.
Most lenders offer 100% offset accounts, but some will offer only a partial offset. Usually partial offset accounts are for home loans with a fixed interest rate. So suppose it is only a 50% offset, this means that if you have $20,000 in the offset account, only $10,000 will offset the mortgage interest rate.
What products will come with an offset account?
Not all home loan products come with an offset account — it’s important to know which ones do, so you can find an option that suits your financial needs:
- Variable home loan products
- Packaged home loans (with variable rates)
- Basic home loans
- Some fixed-rate home loans (very limited options)
Check your Loan Features
When you want to take advantage of an offset account, it is important to decide whether you want a variable or fixed interest rate. If you have the capacity to save, then a 100% offset on variable principal and interest repayments can save you a lot over the long term.
If you have a partial offset, you will not save as much in interest on your home loan. You need to decide which offset account is right for you.
Make sure you ask your lender which one applies to the home loan they are offering you before you sign the contract.
If your lender doesn't offer an offset account, they may provide you with an option to include a redraw facility on your home loan. To see the difference between redraw and offset accounts, click here.
Other considerations before opening up an offset account
In addition to the above-mentioned points, it's noteworthy to point out things which require consideration before setting up an account.
Does it work with your property buying strategy?
We all buy property for different reasons — to be the owner-occupier, as an investor — and depending on your buying strategy, you may need professional advice to see whether an offset is suitable for your needs. For example, if you’re risk-averse and an owner-occupier, you may prefer to fix the full amount of your loan as an offset account has a variable rate.
Does it change your savings strategy?
Generally speaking, using an offset account is a better option compared to parking money in a savings account or term deposit. Savings accounts roughly earn about 3% interest, but an offset account will offset the interest paid on a home loan, which is usually more than 3%. Assess whether keeping your savings in an offset account is better for your long-term financial health.
How do you set it up?
In most cases, your banker or mortgage broker would set up this account as part of their service. But if you want to do it yourself, it's relatively simple. Once you establish that you are entitled to an offset account, you can simply open a transaction account and change this to an offset account. Some banks might need you to complete a different form, while for others it might just be a simple switch.
Can you have multiple offset accounts?
With some banks, you can have multiple offset accounts linked to one variable loan. For example, with a St.George Bank Advantage Package Home Loan, you could have 99 offset accounts, but there is a catch — the first account is free, while the rest will cost you $5/month (unless you deposit $2,000/month). Be sure to read the fine print if you choose to set up multiple offset accounts.
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