What is an offset account and how do they work?

What is an offset account?

An offset account is a transaction account linked to your home loan. By offsetting the mortgage balance, you only have to pay interest on the difference between the loan balance and the amount available in your offset account.

Most lenders offer the option of offset linked with a variable rate home loan. There are also a handful of lenders who provide the ability to link an offset account to a fixed rate home loan.

How it works

Like any transaction account, you can deposit your earnings into your offset account for everyday use. Any funds you put in this account will automatically reduce the interest payable on your home loan. For example, if you had a loan of $400,000 with $50,000 in an offset account, you will only pay interest on the balance of $350,000.

When you have an offset account, your monthly repayments may stay the same but you end up paying off more in principal (your loan amount). This is because when you offset the amount of interest you owe, your repayments are then put towards your principal, which helps you pay off your mortgage faster. Other lender’s repayments will to take into consideration the additional payments made.

How is the interest calculated?

Interest on a home loan is calculated on a daily basis. At the end of each day, the lender will confirm the balance of funds available in your offset account. This is taken into consideration when calculating the interest that needs to be added to your loan. It is a good idea to have any additional savings, as well as having your salary paid into the account as it will save you in paying interest.

Types of offset accounts

1. Balance offset account – this type of account offsets up to 100% of the mortgage balance, with interest payable on the balance of the account. Some loans offer partial offsets, so for example, interest on your mortgage by 50% of your offset account balance.
2. Interest offset account – less common than the balance offset account, this type of account offsets the interest payable on your mortgage by the interest earned in your account. If the interest rate of your offset account is lower than that of your mortgage, you will be disadvantaged and better off choosing a loan with a balance offset account.

Benefits of an offset account

1. Interest rate savings – if you have a sizeable amount in your offset account, you can save thousands of dollars in interest and shave years off your mortgage. As the interest rate on home loans are generally higher than interest rates on savings account, the interest that you save with the offset account will be higher than the interest gains in saving your money elsewhere.
2. Easy to use – offset accounts work like an everyday transaction account, and you can have salary credit s paid into this account. It’s easy to make deposits and withdrawals, compared to a redraw facility. Having the account linked to your home loan also makes it easy to check balance and transfer money between accounts.
3. Flexible – offset accounts allow you to deposit and withdraw funds whenever and however much you like. It’s a convenient way to keep extra funds at hand whilst still minimising your interest payments. In the case of contingencies or sudden expenses, you will be able to instantly access money from the offset account rather than redrawing from your home loan.

Drawbacks of an offset account

1. Higher fees – home loans with offset accounts generally attract a higher monthly or annual fee, so it’s important to weigh up the costs of the fees with potential interest savings.
2. High interest rate – like the fees, interest rates may be higher on a comparable loan without an offset account.
3. Minimum balance – some loans will require you to have a minimum balance in the account to receive the potential benefits and access the available funds.

Offset Account vs Redraw facility

Both offset accounts and redraw facilities are helpful tools for borrowers wanting to reduce their interest payments and pay off their mortgage faster. Some of the key differences include:

• Accessibility and flexibility – money in an offset account can be accessed instantaneously. You may not be able to access the money on the same day with a redraw.
• Approach to savings – An offset account holds all your extra savings whereas the redraw facility requires you to make the extra repayments and only redraw the extra that you paid.
• Fees – offset account generally charge an annual or monthly account-keeping fee whereas a redraw facility charges you when you redraw money.
• Tax implications for investors – if you are an investor, you will need to demonstrate that the use of funds redrawn are for investment purposes, otherwise you won’t be able to claim these funds as tax deductions. On the other hand, offset accounts won’t have this issue. The total loan balance is always tax-deductible.

Should I get an offset account on my home loan?

An offset account is a helpful tool for borrowers who want to offset interest rate on their mortgage balance in order to pay it off quicker. It’s also great for people looking for a flexible way to manage their excess funds and realise the interest and tax savings that comes with it.