What is an offset account on a home loan?
What is an offset account on a home loan?
Katy Holliday - 21 Apr, 2021
Looking to pay off your home loan balance sooner? Whether you’re about to take on a new home loan or have an existing one, there are lots of clever ways to reduce the interest you pay and decrease the lifespan of your loan. One strategic way to do this is by switching your everyday bank account to an offset account.
Read on to find out more about what an offset account is, the different types of offset accounts and how it could potentially help you bring down the balance and reduce the life of your loan.
What is an offset account on a home loan?
An offset account or mortgage offset works like a regular bank account, except that it’s linked to your home loan. It allows you to reduce the interest charged on your home loan by offsetting the balance with any money you keep in the account, while still being able to access your money whenever you need it.
With an offset transaction account, you’ll only pay interest on your home loan balance minus the offset account balance (or portion of the offset account balance). This means, the more money you have in your account, the more your interest payments will be reduced.
How does an offset account work?
With a major financial commitment like a home loan, an offset account can help you pay off your mortgage faster. You can deposit your salary into your account and manage direct debits for bills. You will be issued with a debit card from your home loan lender when you first set up your account.
Some financial institutions offer a 100% offset account, and this is usually linked to a variable rate loan. The balance will offset daily against the home loan principal and decrease the interest amount you have to pay because it’s calculated on the lower loan balance.
For instance, if you have a home loan of $300,000 with $50,000 in your offset account, in this scenario, you’ll only be charged interest on a home loan balance of $250,000 ($300,000 – $50,000).
With an offset account, you can still use your savings at any time, although it will reduce the amount of money you save in interest payments on your loan.
You have the potential to save a significant amount of money in interest payments over the life of your loan, especially when you continue to keep using the offset account as a savings account. The more money you have in the account, the less interest you pay.
Does an offset account reduce my monthly repayments?
When using an offset account, your monthly repayments generally remain the same in dollars, despite being charged a smaller amount in overall interest. However, because the amount of interest added to your loan is reduced, you could pay off your loan much sooner.
With more money in each repayment going towards repaying off the principal of your loan, instead of repaying off the interest, you could shave months or even years off your loan.
How is interest calculated on an offset mortgage?
When you offset your mortgage, interest is calculated on your principal home loan balance minus your offset account balance.The table below displays the difference across three years between a standard variable loan with a 4.77% rate on a $300,000 home loan and the same loan with an offset account attached with consistent savings.
How can I use an offset account?
Here are a few ways you can use an offset account to help pay off your home loan faster:
1. Calculate potential interest savings
Your potential interest savings is determined by how much you “offset” your home loan, your variable interest rate and your principal loan amount.
For example, if you have a 30 year term on a home loan of $500,000 and you manage to maintain a balance of $50,000 in your offset account for the entire length of the loan, you can save approximately $142,000 in interest and could pay off your loan four years and four months earlier. That’s a big savings!
Our loan repayment calculator can help you calculate your potential interest savings and show you how much sooner you could pay off your loan using a set of variables from the loan amount, term, interest rate, extra repayments and your offset account balance.
2. Replace your bank account with your offset account
If you’re signing up for a home loan with all the bells and whistles, it’s likely it will come with a monthly fee and a higher interest rate. You’ll want to make the most of the features it offers by replacing your regular bank account or savings account with a new offset account.
Your bank may even offer you the ability to open multiple offset accounts, which you can allocate to different purposes (one for savings, one for bills, one for general spending, etc). However, some banks do have limits on how many accounts you can open and may have additional fees, so check the terms and conditions first.
3. Deposit salary straight into your offset account
The first thing to do when setting up an offset account is to change your account details with your employer. When you have your salary deposited directly into your offset account, it will immediately be offset against your loan that day. With an offset account, every dollar counts, every day!
4. Combine offset with credit card repayments
Because the interest on your home loan is calculated daily, you can keep more money in your offset account during the month by using a credit card for everyday expenses. This means you’ll be charged less interest on your home loan.
Ensure you remember to pay off your credit card balance for the month by the due date to avoid late payment fees and purchase interest, which would negate any potential home loan interest savings otherwise.
What are the types of offset accounts available?
Lots of home loans in Australia come with an offset account, and there are two main types:
- 100% offset account
- Partial offset account
Make sure you know the conditions of your home loan, because whether you have a 100% or partial offset can make a huge difference to the interest you pay.
What’s the difference between partial and 100% offset?
Commonly, lenders offer a 100% offset account. The money you keep in your account matches the interest reduction you would get if you paid that amount directly to your home loan.
However, in certain cases, your lender may offer you a partial offset account only. This is typically more so with a fixed rate home loan. You may be offered a partial offset facility that offsets a certain percentage of the balance in your offset account, instead of the full amount.
For instance, if your loan comes with an attached 50% offset, and you have $20,000 in that offset account, $10,000 of your balance would go towards reducing the principal. On a $300,000 loan, you would only pay interest on $290,000 of your balance.
If you had a 100% offset, in this scenario, you would pay interest on $280,000 of your balance, saving you more money than with a partial offset.
What types of home loans come with an offset account?
Commonly, an offset account is linked to a variable rate home loan, but sometimes they are offered with a fixed rate home loan or a split loan.
If you want a 100% offset account, then the right option for you will likely be a variable rate loan. If you opt for a split loan, an offset account may be offered, but only to reduce the amount of interest paid on the variable part of the loan.
For example, if you had a fix on $300,000 of your home loan and a variable on the other $300,000, with a $50,000 offset in your account, you would receive the offset for just the variable portion, which would be $250,000. Whereas, with a variable rate loan, you would get an offset for the balance of $550,000, helping you to pay off your loan much sooner.
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What are the benefits and limitations of an offset account?
An offset account is a great way to save money on your home loan, but you’ll need to weigh up both the pros and cons.
The benefits:
- It’s tax free. The money you save by reducing the interest you pay on your home loan is not classed as income.
- You can reduce the amount of interest you’re charged over the term of your loan with every dollar that’s in your account
- You can transfer money and make payments online
- You’ll receive a debit card for EFTPOS payments and ATM withdrawals
- Any windfall money you get, will be used wisely
- You can redraw on the amount that’s in your offset account without being charged a fee.
The limits:
- You’re not actually reducing the principal of the loan
- You may be charged a bigger fee with your home loan package for having the offset included.
What should I know when choosing an offset account?
Not all offset accounts are created equally. When selecting a home loan with an offset account look for features, such as:
- A 100% offset of your total balance against your home loan, rather than a partial offset
- Easy access to your money
- No minimum or maximum balance limit
- No penalties for redrawing funds
- Low or minimal fees
- The ability to have multiple offset accounts linked to the one loan (to save for different things)
Can I withdraw from an offset account?
Does it cost extra to have an offset account?
Generally, home loans that offer an offset account facility will bring with them a steeper monthly service fee than a ‘no-frills’ home loan that might have no monthly fees.
You may also receive a higher interest rate, especially if you opt for a full feature home loan that includes other features like home loan portability, fee-free extra repayments and a redraw facility.
What’s the difference between an offset and redraw facility?
When looking to reduce the amount of interest you pay on your home loan and, ultimately, pay off your mortgage faster, redraw facilities and offset accounts can both help you with your goals. However, they are used differently.
While an offset account acts like a regular transaction account, where you can access the money with your debit card and make payments and transfers as needed, a redraw is completely different.
With a redraw facility attached to your home loan, you’ll be able to access available funds from any extra loan repayments you’ve made on top of your required monthly repayments, after adjustments.
Say you pay an extra $3,000 into your loan account, it will reduce the interest portion of your loan, but then you can still ‘redraw’ that $3,000 if you need to later, and use it for something else. You’ll have same day access to your funds.
Over the course of your loan, the redraw amounts will reduce so that at the end of your loan term your available redraw and your loan balance will be zero.
A redraw facility doesn’t give you the same flexibility as an offset account and you’ll need to check with your lender in advance to see if they require you to pay a redraw fee.
What other home loan features could I consider?
If you’re savvy with your mortgage, you could save a lot of money over the life of your loan. Offset account and extra repayments facilities offer you a great way to reduce the interest you pay on your loan, while also allowing you the flexibility to use that money later on, if needed.
Some other strategies you could use to help you save money on your home loan are to:
- Get a competitive interest rate (negotiate with lenders or refinance later)
- Keep your repayments consistent, even if you get a lower interest rate
- Pay in fortnightly increments, rather than monthly. There are only 12 months in the year, but 26 fortnights, which means you will pay an extra monthly repayment every year with this method.
Words by Katy Holliday
Sources:
- Offset home loans , everything you need to know
- Redraw vs offset explained
- Using an offset account to help pay off your mortgage sooner
- What is an offset account?
A professional mortgage broker at eChoice can help you determine whether an offset account is the best route for you. Chances are you will have a few options to weigh up.