A home mortgage loan is one of the biggest financial commitments you’ll make in your life. And because of that, it’s only natural for you to search for the best home loan deals or wait for the lowest interest rates to be offered before making a commitment.
However, there’s an alternative that can help you reduce the amount of your mortgage payment and interest, allowing you to pay it off sooner. And that’s a home loan offset account.
This article discusses the basics of a home loan offset account, its pros and cons, and some tips on how to effectively maximize your savings.
Home Loan Offset Account: What Exactly is it?
Basically, an offset account is a transaction account connected to your mortgage loan. This means you can withdraw from or make deposits into this account like a regular transaction account.
The only difference is that when you’re holding money in an offset account for a period of time, it can reduce the amount of interest charged on your mortgage. And the higher balance you hold for a longer period, the less mortgage loan interest you will pay. This can help you pay off your mortgage loan sooner.
In general, an offset account is only available for variable-rate mortgage loans. However, some lenders may offer an offset account feature on fixed-rate mortgage loans.
How does it Work?
The point of an offset account is to reduce the amount of borrowed money on which you’re paying interest and help shorten the term of your mortgage.
Here’s an Example:
Let’s say you have a AUD$600,000 balance on your mortgage loan, and AUD$30,000 in your savings account. If you transfer and keep that AUD$30,000 in an offset account, the interest on your mortgage will only be charged to AUD$570,000 and not AUD$600,000.
You will not receive interest on your AUD$30,000 deposit in the offset account. Instead, it is offsetting and reducing the interest that would otherwise charge on your mortgage loan.
With that said, the potential savings from an offset account over the life of a 30-year loan is approximately AUD$130,000 in interest, shaving more than 3 years off your mortgage loan. All because you’ve kept the extra AUD$30,000 in an offset account.
So, while your offset account isn’t receiving any interest, your money is still working hard. Take note that as regular savings or transaction account, the money in your offset account is still accessible. This means you can withdraw from it anytime you need funds.
However, if you do make a withdrawal, it would affect the interest that’s going to be charged on your mortgage.
Different Types of Offset Accounts
There are several types of offset accounts, depending on what your loan provider can offer:
Full Offset Accounts
Also known as 100% offset accounts, a full offset account uses every dollar in the account to reduce and offset the interest in your mortgage loan balance.
This type of account is usually available for variable-rate mortgage loans. Any accumulated interest on your offset account is removed from the interest you pay every month on your mortgage loan.
Partial Offset Account
In this type of account, the accumulated interest in your offset account is at a lower rate than what’s charged on your mortgage loan. For instance, if your mortgage loan rate is 3%, a partial offset account may only have a 1% rate interest. It can still provide you with savings, but it’s not as good as a full offset account.
Fixed Partial Offset Account
This is a less common type of partial offset account that is available for certain fixed-rate loans. Here, only a part of your balance will be used to offset your mortgage loan.
For instance, if you have a 30% partial offset account with an AUD$300,000 balance on your mortgage loan and savings of AUD$45,000, you would offset AUD$13,000 from your loan balance and pay interest on AUD$287,000.
The Pros of Offset Accounts
Save on Interest Repayments
The higher balance you keep in your offset account, the more you can save on interest costs for your mortgage loans.
Reduce the Length of Loans
By reducing the mortgage balance you are charged interest on and still keeping your repayments the same as before, you can pay off your loan faster.
An offset account is like any transaction or savings account. You don’t have restricted access to the money, which means you can withdraw anytime you want.
Potential Tax Benefits
The interest benefit of your offset account is not considered taxable income, meaning you can save on potential tax fees.
The Cons of Offset Accounts
Relatively Higher Interest Rates
The interest rate for mortgage loans with an offset feature is usually higher. So, crunch the numbers to ensure that it is right for you.
Relatively Higher Fees
An offset account may come with extra fees, so make sure to ask your lender and understand the cost.
Financial Discipline Required
You need to keep your money in an offset account for a longer period. So, if you have a habit of regularly withdrawing, you may not enjoy the full benefits of this account.
Large Deposit Required
Due to the extra cost and higher interest, for an offset account to be worthwhile, you may need a substantial balance in your account.
How to Maximize Your Offset Account
In order to make the most out of your offset account, you should deposit any money or earnings into your offset account instead of your savings account.
If you have AUD$ 22,000 in a term deposit, or if you just got your year-end bonus, or inherit a lump sum, it may work harder for you in a home loan offset account.
You may think that locking your savings into a higher-interest account is better. However, the home loan interest is typically higher than the rate of your transaction or savings account. Also, you’ll need to pay income tax on the interest you earn. This is why it makes more sense to put your extra funds in an offset account instead.
You can also deposit regular savings payments into an offset account— whether it’s your salary or savings. So, let’s say, you’re putting away money for your yearly holiday trip, depositing it into an offset account can provide benefits to your home loan, and you can still withdraw it when you’re ready to book.
In addition, you can also combine your offset account with your credit card payments. If you’re really disciplined, using a credit card can defer your daily expenses by being smart with an interest-free payment period.
The trick here is to always pay the full balance when it’s due since credit card interest will be much more than the mortgage loan interest you pay.
Having a home loan offset account can help you better manage the interest payable on your home mortgage, so you can pay off the debt earlier. We hope that this guide has given you a clearer understanding of an offset account and the perks it offers.
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