What is a mortgage offset account?
A mortgage offset account is a savings account or a transaction account linked to your home loan account.
The account’s balance (or a proportion of that balance) is ‘offset’ daily against your home loan balance, and as a result you’re only charged interest on the difference between the total loan balance and the amount offset.
This means the lender charges you less in interest because they are not charging you interest on the full, actual remaining balance of your loan.
Offset accounts may be linked to either a variable rate loan or a fixed rate loan. Some home loans may specify that the offset applies for a fixed term, such as a 100% offset for a year against a 1-year fixed rate loan.
How does an offset account work?
Offset accounts work by offsetting up to 100% of the balance of the linked savings or transaction account against the balance of the linked loan.
In the case of a mortgage offset account, the balance of the account reduces the balance of the mortgage that incurs interest. For example, if you had a loan of $100,000, with $10,000 in a linked 100% offset account and $0 repaid, you may only pay interest on $90,000 of your balance.
Types of offset accounts
There are two types of offset accounts:
- Balance offset account: These accounts offset the interest payable on the mortgage by the balance of the account. The percentage of the balance that will be offset can range right up to 100%. However, a partial offset account may only offset your mortgage by a portion of the balance, for example, a 50% offset account will only offset the interest bearing portion of your mortgage by 50% of your offset account balance. So the higher the percentage of the offset account, the more you will save in interest on your mortgage.
- Interest offset account: These accounts offset the interest payable on your mortgage by the interest earned in the account. However, this could be substantially less than the interest rate of the mortgage. Depending on the interest rates of your mortgage and offset account, these accounts are likely to be significantly less favourable than balance offset accounts, but they are also less common.
Pros and cons of an offset account
First, by having a decent amount of money in your offset account, you might effectively cut years from your home loan and pay thousands of dollars less in interest. You don’t necessarily need a huge amount of spare savings, though – every cent in your offset account is saving you money in interest off your loan, for a 100% offset account.
Secondly, an offset account is simple for most people to manage. You could have your salary deposited into a standard savings account or transaction account every payday, and if it was linked as an offset account to your loan it would automatically save you money on your monthly interest payments.
And thirdly, having an offset account can be an easy way to keep excess funds at hand while still minimising your interest payments on your mortgage, so if your financial situation changes or if something unexpected like a medical emergency were to happen, then you will be able to easily access the money that has been offsetting your mortgage instead of having to redraw on extra repayments you have made on your home loan, which is often limited to minimum amounts and/or come with fees.
However, keep in mind you may find yourself either paying an additional fee for a loan with an offset account, or alternatively, you could end up paying a higher interest rate on your mortgage. The financial benefit of a mortgage offset account will depend on a number of factors, such as the interest rate and fees of comparable loans (with or without an offset facility) and how much money you are likely to keep in your account. So, it is important to weigh up your individual circumstances and determine if an offset account is right for you.
Are your monthly repayments the same with an offset account?
As you can see, when you have an offset account, your monthly repayments typically stay the same in dollar amounts. However, this can be a good thing because it means you can repay your loan faster.
Each month, more money is going towards paying off the principal (your loan amount) because the offset amount is reducing how much interest you owe. Reducing the amount of interest you pay each month can help you to put more of your money towards repaying principal portion of your loan faster.
How do you choose the right offset account for you?
When choosing a home loan that allows an offset account, consider features such as:
- An account where 100% of your total balance is offset against your loan.
- No minimum balance, so every cent in your offset account is working for your loan.
- No maximum balance limit, so you can keep growing your savings and paying less and less in interest on your home loan.
- Low or no fees on the offset account.
- The ability to use your offset account for the transaction types you need, e.g. debit card, ATMs, EFTPOS, BPAY, direct debit, and in-branch.
- The ability to link multiple accounts as offset accounts to your loan.
- An equal or superior savings interest rate to your mortgage interest rate, if possible.
The last point is particularly important if your mortgage is being offset by an interest offset account. If this is the case, you don’t earn interest in the traditional sense, but rather you are offsetting the interest of your mortgage. This may have different tax implications for you compared to if you were earning interest in the traditional sense, so consider contacting the Australian Taxation Office or seeking professional tax advice.
Offset account vs redraw facility?
Offset accounts and a redraw facility are both common features of a home loan, and it is important to know which would work best for you:
- Money sitting in an offset account remains at call and accessible, whereas you must make an application to withdraw money using a redraw facility, so it isn’t always accessible the same day.
- An offset account just holds any spare savings you have, while a redraw facility is only available for any additional repayments you have made above and beyond your usual monthly repayments. You can only “redraw” the extra that you have already paid.
- Offset accounts may have low or no account-keeping fees and some transaction fees, compared to the redraw fee that is typically charged to redraw money using a redraw facility.
- Offset accounts require self-discipline to save money instead of spending it, while redraw facilities enforce discipline for many people, because you have to apply in advance if you want to redraw money to spend.