What is an Offset Account?
People who are smart with their money will plan to put aside some money even when they are paying off their mortgage. An offset account is where you can store these savings – and it rewards you for doing so.
It’s an account that offsets its balance against the balance of your home loan. Which is to say, if your principal was $500,000 and you had $20,000 in your offset account, you would only pay interest on $480,000, rather than $500,000. Paying interest on a smaller proportion of your balance over a long period of time could save you thousands of dollars and help you pay off your loan much faster.
How do offset accounts work?
There are generally two different types of offset accounts: 100% offset accounts and partial offset accounts. If you have a 100% offset account, 100% of the balance in your account is deducted from the outstanding principal before interest is calculated for that month.
Meanwhile, if you have a partial offset account, you will receive a discounted interest rate on the amount of your home loan that’s equal to the amount inside the offset account. For example, if you had a principal of $500,000 and $20,000 in your partial offset, you would pay reduced interest on $20,000 of your home loan and regular interest on the remaining $480,000.
The above two types are the most common, but there also a number of other types of offset accounts. For example, some deduct a certain percentage of your bank account balance from your interest before calculating your monthly interest, while others deduct any interest earned on your account from the interest payable on your mortgage.
Pros of an Offset Account
Reduces interest - Offset accounts can help you save a considerable amount of interest payments, and this means you’ll be able to pay your loan faster.
Increased flexibility - Unlike some savings accounts, the majority of offset accounts will allow you to deposit and withdraw funds whenever you like. This is particularly helpful if your financial situation changes or if something unexpected happens.
‘Automatic’ savings - Whether you’re a consistent saver or someone who saves on an adhoc basis, you’ll benefit from your account’s offset feature, as interest is calculated on a daily basis. This means that, if you have a 100% offset account, every dollar in your account saves interest every day it sits there. So, by having your wages paid into your offset, you will cut into the amount of interest you have to pay, without even thinking about it.
More efficient than regular savings accounts - When it comes to paying back your home loan, offset accounts are generally more effective than online savings accounts, as online savings accounts earn less interest than the amount of interest offset accounts deduct from your mortgage. This is mainly because mortgage interest rates tend to sit around the 4% mark, which is higher than the interest paid on most savings account, and partly because you have to pay tax on the interest you earn with a savings account.
Cons of an Offset Account
Lenders may charge you higher interest - Most home loan providers charge higher interest rates on mortgages that have offset accounts, which means that borrowers often need to deposit a fair bit of money into their offset account before they begin to benefit from the facility.
Fees - In addition to charging higher interest rates on mortgages with offset accounts, some lenders charge additional fees for monthly account keeping and withdrawals.
How much could I save using an offset account?
Following from the example earlier, if you have a principal of $500,000 and keep $20,000 within your offset account for the life of a 20-year loan, you would roughly $11,000 less on interest over the course of your mortgage.
You need to do your homework before signing up for an offset account, as each lender offers very different types of accounts. Be mindful, too, that there are some situations when an offset account won’t suit you, like when you want to increase your equity or reduce your loan repayments. In these circumstances, it may be better to make extra repayments instead.
Always assess your financial and personal situation to determine whether an offset account makes financial sense for you. And remember: discipline and consistent saving are often the most important factors when it comes to paying off your mortgage.
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