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.
There are a lot of things that can help with a home loan. This isn’t one of them. This is just a garden gnome I bought for my house. Something that can help is an offset account. An offset account - is a savings or transaction account, that’s typically linked to an eligible home loan. It lets you “offset” the amount you owe on your home loan so that you’re only being charged interest on the difference. Clear as mud?
Basically, if there’s a loan balance of $200,000 and $10,000 in the offset account, interest will only be charged on $190,000 of the loan balance. This way, the amount of interest that’s being paid each month is reduced, thereby reducing the amount of time it takes to pay off the loan - because your repayments will be paying off more principal rather than interest. And because interest is calculated daily, every cent in the offset account will reduce the amount of interest being paid on the home loan.
It’s also very simple to use as it essentially operates in the same way as a savings or transaction account. The money in the offset account is still accessible, should it be needed, and unlike the interest earned on a savings account which is taxable, the savings you make through reducing the interest you pay on your loan is not considered income, so no tax needs to be paid on it.
There are, of course, some things worth considering when it comes to offset accounts. For example, a decent amount of money is required to get any value out of it. There are many different kinds of offset accounts, and they’re not all created equal. Some places charge a higher rate for having the offset account included in your home loan package, and they may also include additional charges, such as monthly account keeping fees.
So, while gnomes might brighten up a home, an offset account could reduce the amount of time it takes to pay for it. To find out more about whether an offset account is available to you and whether it’s right for you, speak to your bank or home loan provider.
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.
Samantha borrowed $325,000 with an interest rate of 3.00% pa over 30 years to buy her first home.
She opted for a loan with an offset account because she wanted to find a way to save money over the life of her loan. She deposited $10,000 into her offset account, so she only pays interest on $315,000.
In doing so, Samantha has shaved ten months off her loan term and will save $14,063 in interest payments if her repayment amount remains unchanged over the term of the loan.
This case study is illustrative only and is not an estimate of the investment returns you will receive or fees and costs you may incur. This case study is based on the following assumptions: a) loan size of $325,000, b) interest rate of 3.00% pa for the entire life of the loan, c) nominal loan term of 30 years, d) repayments are principal and interest ($1371 per month), e) no withdrawals are made from the offset account (ie the balance remains as described above).
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 of 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.|
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