What is an offset account?

An offset account puts your money to work to help pay off your mortgage sooner. It sounds too good to be true, so how does it work?

An offset account is usually an everyday transaction account linked to your home loan. You can normally use your offset account to make regular transactions through a debit card, ATMs or EFTPOS. You can also have your wage or salary deposited into the account.

What sets an offset account apart is that it lets you use your money in the account to reduce the interest paid on your home loan, so you may become mortgage-free sooner.

Here’s how an offset account works, and what you can do to maximise the savings.

How does an offset account work?

An ‘offset’ home loan consists of a regular mortgage plus a linked offset account.

You won’t be paid interest on money in the offset account. Instead, the balance of the offset account is deducted from – or ‘offset against’ – the outstanding balance of your home loan when monthly loan interest is calculated.

For example, let’s say you have a home loan balance worth $500,000, and $20,000 in the linked offset account. Rather than receiving interest on the deposit of $20,000, and paying interest on the full balance of the loan, interest is calculated on the first $480,000 of the home loan ($500,000 loan less $20,000 offset account).

In this way, you pay less interest on the loan. And, as your home loan repayments will remain the same (unless the rate changes), the interest component of each repayment is lower thanks to the offset account. So, more of each payment goes towards whittling away the loan principal.

When this pattern is repeated month after month, the loan pendulum starts to swing in your favour, helping you become mortgage-free sooner, with the potential for valuable interest savings along the way.

Is it better to have money in an offset or savings account?

It always makes sense to have savings you can call on in an emergency. But if you have a home loan, an offset account can be a valuable tool to make your savings work hard while still having your money at call.

An offset account can also have tax benefits compared to a regular savings account. (It’s best to consult a suitably qualified tax professional.) Interest earned on savings is usually taxable, and a high income earner can lose a considerable amount of their interest to income to tax.

By contrast, with an offset account, you haven’t received any interest on your spare cash, so it’s not included in your taxable income. Yet, you are still getting the full benefit of your savings by using the money to pay off your home loan sooner.

What types of offset accounts are there?

Offset accounts are commonly linked to variable rate home loans, but they can also be linked to a fixed rate home loan.

More broadly, there are two main types of offset accounts:

• 100% offset account: This sees the full (100%) balance of the linked offset account deducted from your home loan balance when interest is calculated.

• Partial offset account: This only offsets part of the offset account balance when loan interest is worked out. For example, with a 50% offset, if you had a loan balance of $350,000 and $50,000 in the linked offset account, you would pay interest on $325,000 of your loan balance.

Fortunately, the majority of lenders offer 100% offset accounts, but this is always something worth checking with your lender.

Are offset accounts worth it?

Offset accounts are very popular with some lenders but they may not be the best choice for every borrower, so it’s important to weigh up whether an offset account will really help you save money.

One thing to be aware of is that home loans with offset accounts tend to come with higher interest rates and fees. If you consistently have only a small balance in the offset account, you could find you are paying more in interest than if you opted for a basic home loan with a low rate and cheaper fees.

How much can I save with an offset account?

If you maintain a sufficient balance, an offset account has the potential to help you save thousands of dollars in loan interest and cut years off your mortgage.

There are a number of online tools that can help you calculate the savings – in both time and money – from using an offset account.

The table below shows a hypothetical example of the benefit of holding either $20,000 or $40,000 in an offset account linked to a $500,000 home loan. We’ve assumed a loan interest rate of 6.40%, which Canstar said was the average standard variable home loan rate in June 2023.

As the table shows, holding a balance of $20,000 in an offset account could deliver a long term saving on loan interest of around $102,411. If you double the value of the offset account to $40,000, the interest savings can ramp up to $183,675 over time, and cut some time from the life of the loan.

Interest saved on $500,000 home loan with an offset account

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Source: www.canstar.com.au 14/06/2023. Interest based on the average owner occupier variable home loan rate on Canstar’s database, available for a $500k, 80% LVR, P&I loan; excluding introductory and other special condition loans. Repayment and interest calculations assume a loan term of 30 years, and that the offset account balance is held constant at the applicable amount for the entire loan term.

What are the potential pros and cons of an offset account?

The financial benefits 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 the linked offset account.

It’s important to weigh up your individual circumstances to determine if an offset account is right for you.

Possible advantages

• Pay less interest on your home loan

By having money in your offset account, you might cut years from your home loan and pay thousands of dollars less in interest. You don’t necessarily need a huge amount of savings, with a 100% offset, every cent in your offset account is saving you money on loan interest.

• Get your savings to work harder for you

Your home loan interest rate will typically be higher than the interest rate you earn on a savings account. Therefore, your savings may work harder for you in an offset account compared to a regular savings account.

Additionally, the interest you save using an offset account will not be taxed. By comparison, separate interest earned on a savings account is taxable.

• Extra funds at hand

An offset account can be an easy way to keep rainy day money on hand, while still minimising interest payments on your mortgage. If your financial situation changes or if something unexpected like a medical emergency happens, you can usually easily access the money in the offset account.

Possible Disadvantages

• Potential for higher fees

You may find yourself paying an additional fee for a loan with an offset account.

• Potential to pay a higher interest rate

An offset home loan can come with a higher rate than a basic loan with fewer features.

• An offset facility only really works if you have money it

If you happen to pay a higher interest rate and fees for a home loan just because it has an offset account, you would likely need to ensure you have the right amount of cash in the account to ‘offset’ the more expensive loan. The loan size, interest and annual fees all come into play when determining how much you need in the account to make it worthwhile. So it’s a good idea to work out your long-term savings goals and whether you’ll have enough money sitting in your offset account to make it work for you. We crunched the numbers to show how having an offset account only saves you money if you have money in it.

Which is better – an offset account or redraw?

Offset accounts and redraw facilities are both common home loan features but there are some differences and it’s important to consider which works better for you – offset or redraw.

Money sitting in an offset account generally remains accessible whenever you need it, whereas you need to make an application to withdraw money using a redraw facility, so it isn’t always accessible the same day. There may also be minimum and maximum redraw amounts.

An offset account can hold 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. Fees may apply when using redraw facilities in some situations.

As it’s easier to access money in an offset account, it’s also easier to spend it. On the other hand, withdrawing money via redraw can take time, which may help to minimise – or prevent – any unnecessary spending.

Additional reporting by Nicola Field and Tamika Seeto
Cover image source: Elle Aon/Shutterstock.com