When searching for your ideal home loan, there are a range of helpful features that can offer more flexibility and reduce your ongoing repayments. One of the most popular features for a home loan which may do just that is an offset account.
What is an offset account?
An offset account is like a transaction or savings account in that it is an active account connected to your home loan and the money in it may be accessed at any time.
However, any funds you deposit into said account will “offset” or help to reduce the amount owing daily on your loan. This may decrease the interest you have to pay, as your interest is now calculated on a lower loan balance.
Put simply, the lender will base your mortgage repayments as if the money in your offset had been paid into your home loan.
For example, if you have a 25-year, $400,000 home loan with a rate of 2.5%, your monthly repayments would be $1,794. If you had the same home loan and $70,000 in your offset account, the lender would base your interest charges as if your mortgage was $330,000. This would mean being charged $314 less for interest each month, which can instead be used to shrink your loan principal and pay off your mortgage faster.
Further, if the $70,000 was deposited at the time of home loan approval, the difference in interest charged over the life of the loan may see you save over $50,000.
Repayments on a $400k loan with and without an offset account
|With an offset account||Without an offset account|
|Amount in offset account||$70,000||$0|
|Interest over life of loan||$86,535.25||$138,340|
Note: Based on a hypothetical 25-year, $400,000 home loan at a rate of 2.5% with $70,000 in offset account from beginning of loan term. Assumes that the offset account balance remains unchanged at the end of each month. Assumes rate does not fluctuate and no fees charged for the sake of the example.
Essentially, an offset account allows you to effectively make extra payments on your loan that can help reduce your interest charges. But unlike standard additional repayments, you may access these funds when needed – without the additional hassles a redraw facility may offer.
What are the benefits of an offset account?
If you’re tossing up whether you should get an offset account, you’ll want to take into consideration it’s advantages and disadvantages. Let’s start with some of the benefits first, which may include:
- Pay less interest – As funds in your offset account help to reduce the principal you owe, the interest charged on your ongoing mortgage repayments should fall too, and allow you to pay off your property faster. Interest is one of the costliest parts of a mortgage, so reducing this in any way may help you to save over the life of your loan.
- Less restrictions – Unlike a redraw facility, an offset account will generally have less restrictions about accessing the funds in the offset account when needed. If you need the funds in a pinch, this flexibility may be a lifesaver.
- Tax advantages – It’s also worth noting that the funds you deposit into your offset account don’t generate taxable income. If the funds you deposit into your offset were instead placed into a savings account, the interest you earn would be taxed. If you have a large sum of money to deposit somewhere, it may be better served in your offset than savings account if these tax benefits are important to you.
What are the disadvantages of an offset account?
There are some downsides involved with opting for a loan with an offset account that are worth weighing up against the pros in your home loan comparison. This includes:
- Limited home loan options – Offset accounts are typically reserved for variable rate home loans. While there may be some exceptions to this rule, generally speaking, you will need a variable home loan to use this feature. If having a fixed rate home loan is important to your financial situation and budget, then this may be worth taking into consideration.
- Pay for the perks – It’s also worth noting that having an offset account linked to your home loan may cost you more in interest and/or fees than if you chose a more no-frills option. A home loan with this feature may come with a higher interest rate or greater annual fees than a lender’s basic home loan. You may also find your lender hits you with a fee for every withdrawal you make, so be sure to read the product disclosure statement before you apply.
- Need money to save money – To see the greatest savings from using your offset account you will need to deposit a considerable amount into it. Unfortunately, a few thousand dollars may only be a drop in the ocean of chipping away at your principal. If you don’t have a savings plan to grow your offset balance over the next few years, then it may not be as effective as you’d like in reducing your repayments.