An offset account is one of the most useful features available on a home loan, but a lot of people either don't have one or don't understand how it works. Here's a clear explanation of what an offset account does, why it's worth having, and how to get the most out of it.
What Is an Offset Account?
An offset account is a transaction account linked to your home loan. The balance in the account is "offset" against your loan balance for the purpose of calculating daily interest. You only pay interest on the difference between your loan balance and the amount sitting in your offset account.
For example: if your loan balance is $500,000 and you have $30,000 in your offset account, you pay interest on $470,000, not the full $500,000. That $30,000 is effectively reducing your interest charge every single day it sits there.
How Much Can It Save?
The saving depends on three things: your loan balance, your interest rate, and how much you keep in the offset account. Even a relatively modest balance makes a difference. On a $500,000 loan at a 6% interest rate, keeping $30,000 in your offset account saves roughly $1,800 per year in interest. Over the life of a 25-year loan, the cumulative saving is significantly larger because less interest also means more of each repayment goes toward the principal.
The more you keep in the offset account, and the longer it stays there, the more you save.
Why It's Better Than a Savings Account
If you have spare cash sitting in a savings account while you have a home loan, you're likely working against yourself financially. The interest rate on your home loan is almost certainly higher than the rate you earn in a savings account. And interest you earn in a savings account is taxable income. The interest you save by offsetting your loan is not income, so it's not taxed.
In practical terms, reducing $1 of interest on your loan at 6% is worth more than earning $1 of interest in a savings account at 4.5%, especially after tax. Your offset account effectively earns you a return equal to your home loan interest rate, tax-free.
How to Use Your Offset Account Well
The offset account works best as your primary transaction account. Have your salary deposited directly into it. Pay your bills and daily expenses from it. The longer money sits in the account before you spend it, the more interest it offsets.
Some people make the mistake of keeping a separate savings account while their offset account sits at zero. Consolidating those funds into the offset gives you the same access to your money with the added benefit of reducing interest every day.
What to Watch Out For
Not all home loans include an offset account, and some only offer a partial offset (where only a percentage of the balance counts). Before assuming your loan has a full offset, check the product details.
Offset accounts are mainly available on variable rate loans. Fixed rate loans typically don't include an offset account, or limit the amount you can offset. If you're on a fixed rate and an offset account matters to you, this is worth considering when you're deciding whether to fix or stay variable.
Some lenders charge higher fees or rates on loans that include offset accounts. It's worth checking whether the net saving from offsetting outweighs any additional cost.
Is Your Offset Account Set Up the Right Way?
At Swish, we regularly find borrowers who have an offset account but aren't using it in a way that maximises the benefit. If you're not sure whether your loan has an offset account, whether you're using it effectively, or whether your current loan structure is working for you, it's worth having someone take a look.
Book a free call with Swish and we'll review your current loan and give you practical advice on getting more from it.