A Mortgage Offset Account is your mortgage’s best friend! Most financial institution offers Mortgage Offset Accounts to varying degrees and using an offset account can vastly reduce the amount of interest you pay on your home loan!
To describe an offset account in its simplest form – it is basically a normal transaction or savings account that is linked to your home loan. Every dollar that you have in your offset account reduces the principal amount that your home loan interest is calculated on. Yep that is correct – for every dollar in your offset account, you pay less interest on your home loan!
Because Mortgage Offset Accounts are normal savings or transaction accounts, you have immediate access to your money. Your money can be withdrawn from the account anytime without needing to redraw your loan.
How does a Mortgage Offset Account work?
When a home loan holder has an offset account the mortgage lender will calculate interest on the loan amount minus the amount in the offset account.
That means when the mortgage lender calculates the interest to your loan, they take the balance in your offset account off what you owe on your mortgage and apply interest on the reduced amount. So at the end of the month when interest is added, a lower amount of interest is added to the loan.
In the example above, assume the monthly interest on a home loan of $200,000 is 5% which equals about $821 per month in loan interest. By using an offset account with an average balance of $10,000, the monthly interest added is $780 – a saving of $41.
When you have an offset account you pay the same mortgage repayments. So when the lower amount of interest is added to your loan at the end of the month, more of your normal repayments go towards the amount you owe (the principal), meaning that the base that your interest is calculated on decreases quicker saving you even more interest as time goes on.
Another way to describe an offset account is an account that accrues the same amount of interest as your home loan, however instead of the interest being paid into the account, it is credited to your loan.
What are the types of Mortgage Offset Accounts?
Mortgage Offset Accounts come in two offset types; 100% Offset and Partial Offset. The 100% Offset is what you are looking for – this means that the full balance of your mortgage offset account is applied to the loan.
A partial offset is offered by banks that don’t want you to save too much! A Partial Offset works the same, however instead of you saving the full interest rate on your home loan; the mortgage provider will reduce the amount of interest by a much smaller amount (typically between 25% – 50%). Using the example above, the saving on the full offset is $41 per month. A partial offset account that provides an offset based on an interest rate of 1.5% would save you $12 per month – a massive difference!
Different lenders also offer different offset account options; full transaction accounts (i.e. card access) and savings only (no card access).
What are the benefits of a mortgage offset account?
Heaps! I have read articles where the author suggests offset accounts are useless – I couldn’t disagree more! Mortgage Offset Accounts, particularly 100% Offsets, offer one of the more effective ways to reduce the amount of home loan interest you pay and also offer an easy way to shorten the life of your home loan.
Using the example above, assuming that you keep $10,000 in your offset for the life of the home loan (say a 25 year loan), you could save over $71,000 in interest and shave almost 5 years off the loan. Pretty effective for $10,000!
Although Mortgage Offset Accounts do not earn interest themselves you are basically getting the same rate of interest as what your home loan rate is (except the ‘interest’ is credited to the loan). This effective interest that you receive by the reduction on your home loan interest is tax free unlike interest on savings accounts. This is benefit enough to make most people listen! This makes using a Mortgage Offset Account even more effective! Why? If you used a savings account instead of the offset account, tax would take away a part of the interest you received.
In reverse, the interest rate you would need to receive before tax would need to be a lot higher to equal the benefit you would get from an offset account. The example below shows how powerful the offset account is. Assuming a High Interest Savings Account paying 3.8% and a home loan rate of 5%, for the differing income tax bands, the table below shows what interest rate you would need to get to match the benefit from an offset account.
|Income||Under $18,200||$18,201 – $37,000||$37,001 – $80,000||$80,001 – $180,000||Over $180,000|
|Interest percentage from a high interest savings account after tax||3.8%||3.002%||2.489%||2.318%||1.938%|
|Before tax savings interest would need to be …% to get the same benefit as an offset account||5%||6.05%||6.725%||6.95%||7.45%|
Why wouldn’t I have a mortgage offset account?
Good question! Not all providers actually offer a mortgage offset account which is something that should be seriously considered when comparing home loans (is going for the cheapest rate along the best option?). Mortgage Offset Accounts are not common on fixed rate home loans although 100% Offset accounts do tend to be offered by Credit Unions and smaller banks.
How do I make an offset Account work for me?
There are two ways that you can use an offset account and this will depend if you are a spender or a saver.
So you’re a spender! You may not necessarily be a ‘spender’ but in this case; you are basically living to the dollar. Because you are not saving, you are not receiving savings interest anyway, so swapping your usual transaction account and using a transaction offset account instead will mean the days that you do have money in your accounts, this will offset your loan. As offset balances are credited daily to home loans, this will help you reduce your loan interest.
You’re saving – awesome! Rather than get taxed and lose a percentage of your savings to the tax man, use your offset account to get effectively a rate of interest that matches your home loan rate. Your home loan balance will reduce quicker and will still have immediate access to your offset balance to use when needed.
Offset Accounts offer you a way to pay your mortgage quicker. Some providers make you pay for the privilege of a Mortgage Offset Account but my advice is to shop around. Many lenders will offer 100% Offset on their basic and fixed rate mortgages at no cost allowing you to use your offset as a transaction account or savings account.
We want to know if Mortgage Offset Accounts work for you!! Have questions, stories or tips, we want to hear from you – start the journey to being your own MoneyGeek and start a conversation below!
Work out the benefit you can get from an Offset Account!
Work out the benefit of an offset account for yourself! Use the calculator below to determine how much you can save. To help you find the right loan and offset account download our Mortgage Offset Checklist!.
Use of this calculator is subject to our Disclaimer found here. Please read the disclaimer before use.
Want to get a Mortgage Offset Account?
MoneyGeek wants to make sure our readers get easy to understand information to assist make the right financial decisions. Not all lenders and home loans have a Mortgage Offset Account. MoneyGeek’s lending partners can assist you find the right home loan and the right offset account – enquire below to start saving money on your home loan!
1 For 2014/15 Tax Year and Includes Medicare Levy and proposed Debt Repair Levy. Does not include Medicare Levy Surcharge (you should have health insurance!). Tax rates current at 31st May 14 and sourced from the Australian Tax Office
About the Author – The Money Geek
The Money Geek is the head money blogger for MoneyGeek.com.au. With over 8 years experience in the finance industry, the Money Geek provides information over a range of topics to help families Australia-wide improve their financial literacy to become their own geeks and take control of their financial future!