Home loan offset accounts: Are they worth it?

• Find out what home loan offset accounts are and how they work.
• Is it better to make extra home loan repayments, or just leave the amounts in an offset account?
• Compare offset accounts with both savings accounts and redraw facilities.

If you are buying a house, or already have a home loan, you may consider having a mortgage offset account. It could save you a lot of money over the life of your loan.

What is an offset account?

An offset account is a bank account attached to your home loan. It is effectively the same as a transaction account, but it has extra benefits.

When you have an offset account, all the money you keep in it is ‘offset’ against your home loan principal, meaning you can save on interest repayments on your loan.

It is usually only offered on variable rate loans – not fixed rate loans – and most lenders will charge you a higher interest rate and/or fee for having an offset account.

Who can get one?

Anyone with a variable interest rate home loan can usually get an offset account with their lender, providing the lender offers offset accounts as part of the package.

How do offset accounts work?

When you set up an offset account, you will be issued with a debit card by your banking institution.

You operate an offset account just like a normal transaction account. You can have your pay deposited into your account and also use it for purchases and to pay bills.

Because the money in your account is ‘offset’ against your home loan principal, it reduces the size of your loan (for the purposes of calculating interest) by the amount in your offset account.

For example, if you have a $600,000 mortgage and $50,000 in your offset account, you will only pay interest on $550,000. Of course, the amount in the offset account will vary regularly, but that’s OK, because home loan interest is calculated daily.

The more money you have in your offset account, the less interest you will have to pay over the life of the loan.

Keep in mind you won’t earn interest on the money in your offset account. But the amount of interest you will save should outweigh the amount it could earn in a savings account, because your mortgage interest rate will usually be higher than the best savings account interest rate you could expect.

How much difference does an offset account make?

Having an offset account can save you a lot in interest repayments over the life of your loan and help you pay off your loan sooner.

Let’s say you take out a $350,000 loan over 25 years at an interest rate of 3%.

You also set up an offset account and maintain a balance of $50,000 over the life of the loan.

Over the loan term, you will only be charged interest on $300,000 of your mortgage.

In this example, you will save $48,000 in interest repayments and slice two years and four months off the length of your loan.

Is it better to pay off your home loan or offset it?

Both approaches have their advantages.

Paying more than the minimum monthly repayment will eat into your principal and can help you pay your mortgage off faster.

If you make larger repayments over a long period of time, you could have much reduced repayments in the final years of the loan, or pay off your loan far sooner.

This approach may especially suit people with a higher disposable income who have had their home loan for a while. If you do make extra repayments, you can always revert to the minimum monthly repayments if necessary.

But those extra payments you make are not as easily accessible as they would be if you left them in an offset account. If a financial emergency arises, you would have to apply to withdraw your extra payments via a redraw facility. Not every loan has one, and there’s also a chance your redraw application might be refused.

Using an offset account may be preferable if you don’t have a lot of disposable income. The offset means you have cash available while still being able to save on interest.

The effects of withdrawing from an offset account

If you withdraw a substantial amount of money from your offset account, you won’t enjoy its full benefits.

To use the previous example, if you withdrew $25,000 from your offset account (which previously held $50,000), you will now be paying interest on $325,000 of your $350,000 mortgage.

If this offset account balance is maintained, you will be paying off your mortgage for longer and paying more interest over the life of the loan than if you had maintained a $50,000 balance in your offset account.

Does an offset account mean lower monthly repayments?

Having an offset account doesn’t usually reduce the amount of your monthly repayments. But the potential to shorten the length of your loan (because you’re repaying more loan principal and less interest) means you can save on interest overall.

Offset accounts vs savings accounts

As well as potentially helping you save money on your mortgage, the other big advantage of an offset account over a savings account is it will help you save on tax.

Any interest you may earn on money in your savings account is considered income and will be taxed.

However, interest you save on your mortgage by using an offset account is just a personal expense saving and is not taxed.

Offset accounts vs redraw facilities

A redraw facility comes into play when you make extra repayments on your mortgage. The loan principal is actually reduced by the amount of your extra repayments, not merely offset.

But you can ‘redraw’ that money if you need it, as long as your loan comes with a redraw facility. The money you withdraw will be added back to the remaining loan principal.

For example, if you make an extra repayment of $2000 on your home loan, the redraw facility gives you access to that extra money if and when you need it.

Redraw facilities are not usually as flexible as offset accounts and you may incur fees for accessing the extra money.

Benefits

The key benefit of the offset account is its potential to shorten the length of your loan by reducing the amount of interest you are charged.

As well, you won’t pay tax on your interest savings via an offset account, unlike with a savings account, where you will pay tax on any interest you earn.

Another benefit of the offset account is you can use it just like a normal transaction account and have your salary paid into it, and pay bills or withdraw cash from it.

Drawbacks

You will probably pay a higher monthly fee to have an offset account, compared with a basic mortgage that might not incur monthly fees.

Your lender may also charge you a higher interest rate to have an offset account.

Another potential drawback is you will have to maintain a relatively high balance in your offset account in order to reap substantial benefits.

As well, some offset accounts are not 100% offset accounts. That is, only a part of the offset account balance may be counted when calculating your interest cost reduction. For example, if you have a $20,000 balance in a 50% offset account, only $10,000 will be offset against the loan principal when calculating interest. Check with your lender to make sure you are getting a 100% offset.

Verdict

If you are thinking of taking out a home loan, or already have a mortgage, setting up an offset account may be worth considering.

If you make good use of it, it can potentially save you many thousands of dollars on your mortgage and shorten the life of your loan.

But you should also consider whether the extra fees and higher interest that may come with an offset account will make it the right option for your circumstances.