Unlike a tradition savings account, an offset account can help you save interest on a mortgage as opposed to generating interest on your savings.
When you deposit money in your offset account, the funds are deducted from your loan balance before interest is calculated. In other words, interest is only charged on the difference between your loan balance and the funds held in offset.
Example of offset accounts in action
Take Kevin for example. Kevin has a home loan of $500,000 and has saved $100,000 in his offset account. Kevin only pays interest on $400,000 which is the difference between the amount owing on his home loan balance and his offset account. This helps Kevin to pay off his mortgage quicker as less money is going to interest costs, allowing more money can go towards paying down the capital.
Difference between offset and redraw
There is often confusion between the offset accounts and redraw facilities. They provide a similar outcome but differ in their mechanics.
An offset account is a separate bank account which is linked to your loan. This allows you to use the funds like you would a normal transaction account, i.e. withdraw money from ATMs, direct debit, BPay, electronic funds transfer, etc.
A redraw facility on the other hand, is not a separate account, it is held within your loan. When you make additional loan repayments, above the mandatory minimum, it will reduce your loan balance. Using a redraw facility, you have the option to take the funds back out of the loan. This typically needs to be done by transferring the surplus funds from the redraw facility to a transaction account.
If we go back to Kevin’s example, if Kevin held $100,000 in redraw as opposed to offset, his outstanding mortgage balance would reduce to $400,000 but his credit limit would remain at $500,000. This means Kevin can redraw $100,000 back out of the loan.
When deciding between an offset account and redraw facility, there are pros and cons of both. Offset accounts are typically preferred if your loan is an investment loan (or will potentially turn into an investment loan in the future) as there may be tax implications of withdrawing from a redraw facility. Please discuss this further with your Financial Planner or Accountant.
Benefits of offset accounts
The BENEFITS of an offset account include the following:
- Reduce your interest outlay: Every dollar you put in the account reduces the outstanding balance your loan interest is calculated on. This can lead to significant interest savings over the life of your mortgage.
- Accelerate repayment of mortgage: Reduced interest means more of your monthly repayment goes towards the principal, accelerating payoff and potentially shaving years off your loan term. This can help you become mortgage-free sooner and save on the total cost of your loan.
- Tax-free “return”: Instead of generating interest, you are saving interest. This offers a tax-free “return” equivalent to the interest rate on your mortgage.
- Maintains the original purpose of the loan: Withdrawing money from an offset account does not impact the purpose of the loan. This can have beneficial tax implications where the linked loan is currently, or will turn into, an investment loan.
- Quick access to funds: Money held in offset is easily accessible when needed. Given this, they can make a great structure to house your emergency fund.
Risks of offset accounts
The RISKS of an offset account include the following:
- Foregone investment returns: Holding funds in an offset account means foregoing potential returns from other investments.
- Account fees: There is often a fee payable to have an offset account. The cost needs to be factored into your overall benefit assessment to ensure that the interest saved outweighs any associated fees. This may deem it inappropriate for a small savings balance.
- Temptation: As offset accounts are easily accessible, this can lead to a temptation to spend your savings. You need to employ discipline when using an offset account.
- Access to an offset facility: Not all lenders provide an offset account. It is particularly uncommon to have an offset facility against a fixed rate loan.
If you think an offset account is an appropriate strategy for you, we strongly recommend you speak with your Financial Adviser or Mortgage Boker. They can help assess the appropriateness for your particular situation.
