Why you should have an offset account
Your home loan is probably the biggest financial commitment you’ll make in your lifetime. So what if there was a way to reduce the amount it costs – the interest you pay – and also pay it off sooner?
There is. It’s called an offset account, and it could save you thousands of dollars if you use it correctly.
It’s really very simple. An offset account is a transaction or everyday banking account that is linked to your mortgage. Every dollar you have in that account ‘offsets’ the balance of your loan – reducing the amount of interest you pay every month. Because these savings add up over time, you can also use this ‘extra’ money to pay your loan off faster.
Many home loans in Australia have an offset account but they are usually only available with a variable rate home loan.
Here’s how it works
Let’s say you have a home loan of $400,000 with an interest rate of 6%, and $20,000 in your offset account. You’ll only pay interest on $380,000. Over the life of a 30-year loan, you can save more than $87,000 in interest, and shave more than three years off your loan.
All because you have kept that extra $20,000 in the right account.
What if you need to use that $20,000 for an emergency? Well, you can – because a mortgage offset account is just like an everyday banking account. You can access your extra funds at any time, although you’ll reduce the amount of interest you’re saving if you do.
3 ways to get the most from your offset account
1. Put any savings straight into your offset
If you inherit a lump sum, or have $10,000 in a term deposit, it may work much harder for you in a mortgage offset.
This may seem counterintuitive if you’re used to locking away your savings into a high interest account. However, because your home loan interest rate is likely to be higher than the rate on your savings account, and you’ll pay income tax on the interest you earn, putting your extra funds into an offset makes much more sense.
For example, let’s say you inherit $20,000 and put that money into a term deposit at 4 per cent interest rate. Once you pay tax on your interest at 32.5 per cent (assumed tax rate), your after tax (net) return is only 2.7 per cent. Is that less than your mortgage interest rate? If it is, your money will work harder for you in your offset account.
You can also set up regular savings payments into your offset account – so if you’re used to putting away money for an annual holiday, you can still do that with an offset and withdraw it when you’re ready to make the booking.
2. Deposit your salary into the offset
If you can get a debit card with your offset and online access to payments, why not use it as your default transaction account and tell your employer to make salary payments into the offset account? Every dollar helps.
Interest is calculated daily on an offset account, so even if the balance goes up and down with your day to day transactions, you’ll still be ahead.
3. Combine your offset with credit card payments
The more money you can keep in your offset, and the longer you keep it there, the more you will save. So if you are really disciplined, you could use a credit card to defer everyday expenses by being clever with the interest free payment period.
The trick with this tactic is to always pay the full balance off when it is due – because the interest on your credit card will be much more than the interest you pay on your mortgage. On the plus side, putting all your monthly expenses on a credit card with frequent flyer points will also give your holiday budget a boost.
Add up the benefits of an offset
With an offset account you can:
- reduce the interest you pay over the life of your loan
- transfer money and make payments online
- get a debit card for ATM withdrawals and store payments.
What should you look for in a mortgage offset account?
Not all offset accounts are the same, so make sure you check the details. Look for:
- a 100 per cent (full) offset account, rather than a partial offset
- easy access to your offset funds
- no balance limit or penalties for withdrawal.
Some banks offer multiple offset accounts linked to one loan, which can help if you’re saving for a few big things (like another property, a holiday, a wedding or a new car).
What’s the difference between an offset account and a redraw facility?
A redraw facility also lets you reduce the interest on your variable home loan – by making extra repayments.
You’ll effectively save the same amount as with an offset, but you may not have as immediate access to your savings (which could be a good thing). You’ll also be increasing your equity in the home, because you’re paying off the principal.
Many home loans offer both. But when it comes to saving as much as you can on your home loan, the most important thing you can do is use them effectively.
Article source: http://www.macquarie.com/au/personal/home-loans/expertise/what-is-an-offset-account
