An offset account is a super-charged savings account that is attached to a loan account. The primary benefits of having an offset account are to lower the interest you pay and the time you take to pay back a loan. But there are several other benefits of offset accounts for more the experienced player, including:
- Retaining ready access to your money even after paying down a loan
- Eliminating the tax that could be paid on interest earnings
- Maximising the amount of future tax deductibility on a loan in certain circumstances
An offset account is usually linked to a mortgage loan. However, businesses also have offset accounts in the form of Accumulated depreciation accounts and Discount on notes payable.
Having your cake and eating it too
You can deposit your wages, salary, and any extra money that you get into an offset account. You do not actually need to use the money to repay the home loan. The fact that the money is in the savings account allows the interest charged on the actual home loan to be reduced based on the amount of money held in the savings account.
Types of offset accounts
There are two types of offset accounts: 100 percent and Partial offset accounts. In 100 percent offset accounts, the total balance in the account is subtracted from the principal of the loan before the interest on the loan is calculated. This lowers the amount of interest paid. However, the offset account does not earn interest. In partial offset accounts, the interest earned is used to pay the principal of the loan and the debtor does not pay tax on the interest. This reduces the amount of time taken to pay off the loan. Partial offset accounts are not very common in Australia as they are more complex and less flexible than 100 percent offset accounts.
How an offset account works
Although an offset account is usually linked to a loan account, it works as a separate account with its own distinct features and benefits. An important distinction between a savings account and an offset account is that an offset is not a part of the loan account. Like a transactional account, an offset account allows you to pay salaries and bills from funds deposited in the account.
To calculate the amount of interest on the loan, the balance on an offset account is subtracted from the principal of the loan before interest is charged hence lowering the interest. The interest saved from having money in an offset account can then accrue in the account to further reduce future interest payments and shorten the time taken to pay back the loan. An offset account is usually linked to a mortgage loan. However, businesses also have offset accounts in the form of accumulated depreciation accounts and discount on notes payable.
Another way to think about an offset account is as super-charged savings account. Rather than receiving interest at the usual bank savings rate, you get the equivalent of earning interest at the same rate as your home loan. Even better, because an offset account saves you interest rather than earning you interest, there is no tax liability to incur. It really makes you wonder why more people don’t use these powerful tools.
Repayments
For Principal and Interest loans it’s common to fix your regular repayment. This means that as your offset account balance increases you will be paying down more and more of your loan with each payment. However for an interest only loan, increasing your offset account will decrease the amount of interest which is charged by your loan each month. It is often simple to have interest-only repayments made from the offset account itself and instead set a fixed monthly repayment into the offset, so that the account balance will grow exponentially over time.
Buffering for difficult times
Life happens from time to time. During difficult periods when income might decrease or stop altogether due to time out of work, an offset account also acts as an emergency buffer. It can be used to meet the minimum loan repayment until income improves.
How much interest can be saved?
The amount of interest saved depends on the amount of money in the offset account and the interest rate. To save as much interest as possible, find a mortgage with a relatively low interest rate and strive to have as much money as possible in the offset account.
Offsets vs Redraws
Many people have the misconception that they have an offset account when they really just have a redraw account. The two seem quite similar but are principally very different and have different tax outcomes.
A redraw facility is an added feature on a loan account. It is not a separate account like an offset. Redraw enables you to pay more than the minimum repayment into a loan and still redraw this back off the loan in future, for personal purposes. Both offer the same benefit in reducing the interest you will pay on your loan, however there are a few additional benefits which offset accounts have that redraws can’t provide:
- Access to a debit card with ATM, EFTPOS and sometime cheque access also
- Option for additional bank products such as credit cards to be attached
- Unlimited access to “redraw” your funds from the offset account
- The underlying loan can remain up to 100% tax deductible even after withdrawing funds out of the offset, whereas this isn’t the case with a redraw
Trust home loans
Some lenders will offer offset accounts for home loans housed in trust accounts. However, the policies that govern these accounts are different from those of a regular loan and often vary from one lender to another. It is advisable to consult your mortgage broker, accountant and financial adviser before opening one of these.
Benefits of Having a Mortgage Offset Account
- The account allows you to deposit and withdraw money from the account at your own will without being charged additional fees. It also helps to reduce interest charged on the loan and the time taken to repay.
- The money in the account is not taxed because it is does not earn any interest.
Disadvantages of Having an Offset Account
- Some banks charge high fees for access to an offset account on a loan. In these cases it’s not always financially beneficial to use an offset if the offset balance will not be very large
- Some banks also limit which type of loans allow an offset account, however these are becoming more and more common, with some banks now offering unlimited offset facilities against each loan
Why consider an offset account?
An offset account can help you save interest and reduce the time taken to pay off the loan. In addition, it provides money to pay the minimum repayments in case the debtor does not have the funds to make required monthly payments on a loan. However, lenders offer different types of offset accounts. Therefore, consider opening an offset account with a lender who has the best terms and conditions.
Does a home loan with an offset account cost more than a standard home loan?
Home loans with offset accounts might have high interest rates or charges. However, due to increased competition, many lenders offer affordable interest rates to attract more customers. The differences between the interest rates of standard home loans and those which offer offset accounts are no longer very significant. In addition, there are significant benefits of offset accounts over standard accounts. It’s important to check with your mortgage broker about various products being offered on the market and which right for you.
Factors to consider when choosing an offset account
- Balance limit – choose an offset account with no balance limit or with a high balance limit.
- Fees & charges – choose an offset account with little or no fees
- Interest rate – choose an offset account whose interest rate is equal to that of the mortgage.
- Number of offset accounts – look for a loan which offers multiple offset accounts so that you can organise your savings into multiple buckets
An offset account can help you repay your mortgage loan quickly. However, it is important to understand its terms and conditions to avoid complications in the future.
Do you have questions about how best to organise your bank and loan accounts? Pose them here so that our community can respond for you, or get in touch with one of our expert advisers and we will help you use offsets to get yourself debt-free and financially independent.