What is an offset account and how does it work?
Having an offset account may help you to pay off your home loan faster and save you thousands of dollars in repayments, but how exactly do they work? Are they worth it? Here we explain.
What is an offset account?
An offset account is an account linked to your home loan that operates like a transaction or savings account. It offsets the balance in that account against the balance of your home loan, so you'll only be charged interest on the difference.
Having an offset account may help you to pay off your home loan ahead of its term and save thousands of dollars over the life of the loan, simply by depositing all your regular income and earnings into your offset account.
These accounts may come with higher costs, so it’s important to crunch the numbers to make sure you’re ahead in the long run.
How an offset account works
Say you have a home loan balance of $400,000 and savings of $20,000. If you keep the $20,000 in an offset account, the interest on your home loan will only be charged on $380,000, not $400,000. You won’t receive interest on the $20,000 in the offset account; instead, that $20,000 is offsetting and reducing the interest otherwise charged on your home loan.
Even though you typically don’t receive interest with an offset account, your money is still working hard for you. The point of an offset account is to reduce the amount of borrowed money on which you are paying interest and shorten the term of your loan.
Like a regular transaction or savings account, your money is still accessible in the offset account. But if you make a withdrawal, you’ll have less money working to lower the interest charged on your home loan.
What’s the difference between an offset account and a redraw facility?
Although an offset account can get you the same results as using a re-draw facility, the two are quite different. An offset account is like a savings account linked to your loan, whereas a redraw facility allows you to draw back (or use) additional loan repayments you’ve made over and above the minimum payments required. Both will give you interest savings on your loan. Some loans offer both a re-draw facility and an offset account, although it’s usually quicker and easier to access funds from an offset account.
How much could you save?
The more money you have in your offset account, the more you could save on interest payments for your home loan, which will likely make your home loan term shorter.
Types of offsets
100% offset account - 100% or ‘full’ offset accounts use every dollar in your offset account to offset the balance in your home loan account. These are typically available for variable rate home loans. The ‘interest’ you accrue on the offset account reduces the interest you pay each month on your loan. More of your repayment comes off the loan principal.
‘Partial’ offset account – the ‘interest’ you accrue in the offset account is at a lower rate than what is charged on your loan. For example, your loan rate is 3% but the offset rate is 1% - still saving, but not as good as 100% offset.
Under another type of partial offset account, which is less common, only part of the balance is used to offset your loan. These types of accounts may be available for certain fixed-rate loans. For example, if you had a 40% partial offset account, with a loan balance of $200,000 and savings of $20,000, you would offset $8,000 from your loan balance (40% x $20,000) and pay interest on $192,000.
The pros and cons of offset accounts
Reduce the length of your loan - by reducing the loan balance you’re charged interest on, but keeping your repayments the same as before, you can pay off your home loan faster.
Relatively higher fees - having an offset account could come with additional fees, so be sure to understand the costs.
Save on interest repayments - the higher the balance in your offset account, the more you can save on interest costs for your home loan.
Relatively higher interest rates - the interest rate for home loans with an offset account are typically higher. Crunch the numbers to make sure it’s right for you.
Potential tax benefits - because the interest benefit from your offset account is not considered taxable income.
A large deposit - in some cases, for an offset account to be worthwhile given the additional costs, you need a substantial balance in the account.
Flexibility - you have unrestricted access to the money in your offset account.
Financial discipline required - if you make a habit of regularly withdrawing from the offset account, you’re unlikely to enjoy the full benefits of the feature.
©AWM Services Pty Ltd. First published Nov 2021