Master the dark arts of using an Offset Account to reduce your mortgage

We all have to learn how to use financial tools to our advantage to get ahead in our financial life.

Learning how to use key financial tools is one of the habits of wealthy people… not learning how to use those same financial tools, are often the habits of people who don’t get ahead.

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What is it called?

One of my favorite financial tools for people with a mortgage is called an Offset Account. Used well, it can save thousands off a mortgage debt.

• An Offset Account is simply a savings account linked to your home loan in such a way it reduces the amount of interest you have to pay on your mortgage.

Why would you use it?

The name of the game when using an offset account is to reduce the daily interest calculation on your mortgage.

Here’s a diagram to help explain the workings of this clever financial tool.

Mortgage interest is calculated on the outstanding daily balance

Funders calculate the interest charge on a mortgage based upon its daily outstanding balance.

• So if your mortgage is currently $150,000 interest charged is calculated on this outstanding daily amount.
• But if you have $20,000 in your offset savings account, linked to your mortgage, the daily interest calculation on the mortgage is made on $130,000. (eg: the balance of the mortgage less the balance in the offset account)

Pro Tip: This assumes you’re using a true 100% Offset Account, and not what we call the watered-down versions we’ll discuss later in this article.

How different people use offset accounts differently,

Regardless of how you use an offset account, the reason you do is to reduce the daily interest calculation on a mortgage.

Six examples of different people using the same offset account structure

You can use an offset account in different ways - all to achieve the same result; to reduce the daily interest calculation on a mortgage.

• Typical families directly credit wages into the offset account, then spend up to their budget while leaving the unspent surplus in the account – to reduce the daily interest calculation on the linked mortgage.
• For the ‘spend it all after paying the bills’ personalities’, directly crediting all wages into the offset account, then transfer out an amount of money to a joint daily transactional account for paying monthly living costs, while leaving the surplus in the offset account to help reduce the daily interest calculation on the linked mortgage.
• For those really good at paying off their credit card balance each month, directly crediting all wages into the offset account, then using a 30 day interest free credit card for the majority of monthly living expenses where possible, then at the end of each month pay off the credit card balance from the money in offset account. This means for 29 days, the balance in the offset account has reduced the daily interest calculation on the linked mortgage.
• If you’re a business owner who puts Tax and BAS obligations aside to pay quarterly, put that money into a dedicated offset account linked to a mortgage (remember on some loans you can have multiple offset accounts linked to the same mortgage) while you wait for the next tax payment quarter to arrive. This means for 4 months a year, the balance in the offset account has reduced your daily interest calculation on a mortgage.
• Parents with surplus funds who do not require them to earn interest, for the time being, can ‘park surplus funds’ into a dedicated offset account to help their adult children to help reduce the daily interest calculation on their mortgage for a time.
• We’ve even seen situations where adult children from large families each use multiple separate offset accounts – all linked to their parent’s mortgage account - to help reduce the daily interest calculation on a mortgage.

The options are endless when you have a good financial strategy and learned how to use a financial tool to get ahead.

Are all offset accounts the same?

No. We believe the best version is the true ‘100% Offset Account’ - all others are poor imitations, and this is what you need to know.

• Historically some banks tried to ‘pull the wool over your eyes’ when it came to offset accounts, creating watered-down versions of the offset account, and hiding the changes in the fine print.
• Some even tried to create an impression the advertised, ‘Offset Home Loan’ actually had an offset account as part of this package - when it clearly did not – perhaps hoping customers wouldn’t understand the difference. 
• Doggie you might say? Well, we’d say the banks marketing departments knew what they were doing and that’s why they did it.

Is it any wonder many people increasingly find it hard to trust the advice from a bank?

The #1 question we’re asked about offset accounts

Q. Will the monthly mortgage repayments go down if I use an offset account?

A. No. Repayments will remain the same because any funds you put into an offset account (or add into the mortgage as an additional repayment) can be withdrawn whenever you choose.

What does happen is the regular repayment on the principal and interest portions of the loan will change and you’ll end up paying off more principal than interest. How much principal you repay will depend upon how much money you have in your offset account that month when the daily calculations are made.

Here are a few of the poor imitations to a true 100% Offset Account

• A 50% Offset account.
  • This poor imitation will only use 50% of the balance in an offset account to offset a linked mortgage – so it’s only half as effective. We’ve even seen 30% offset account still sold under the same generic name ‘offset account’.  Don’t be fooled by this trick.
• An Interest Offset account.
  • This insipid imitation is made even worse because hidden in the fine print is the explanation, ‘only the interest earned on the balance of the offset account is used to offset the daily calculation' of the outstanding mortgage.
• The offset you have when you don’t actually have one.
  • The ‘Offset Mortgage Loan’ – all you get is the warm feeling that it's magically doing you some good, like an offset account could, but you don’t actually have one. It's just the name of the mortgage product.

Pro Tip: As an offset account doesn’t earn interest on its balance, (it just offsets the daily calculation on the linked mortgage) there’s no interest income to declare on your tax return.

What’s the difference between an Offset and Redraw facility?

Redraw facilities work in a similar way to offset accounts, but they have different features and flexibility.

• Redraw facilities are less flexible and are like ‘parking surplus money’ into the mortgage account directly
• Offset accounts are linked to the mortgage and put surplus funds to use while they're waiting to be spent on living expenses then replenished the following month

Both options can reduce the daily interest calculations – just in different ways.

Regardless of the type of money manager you are, learning how to play to your strengths and reduce the temptation to habitually spend everything you earn, is a necessary life skill to learn, to help you and your family get ahead.

So spend some time learning how to master the not-so-dark arts of an Offset Account.

Drew Browne is a specialty Financial Risk Advisor working with Small Business Owners & their Families, Dual Income Professional Couples, and diverse families. He's an award-winning writer, speaker, financial adviser and business strategy mentor. His business Sapience Financial Group is committed to using business solutions for good in the community. In 2015 he was certified as a B Corp., and in 2017 was recognised in the inaugural Australian National Businesses of Tomorrow Awards. Today he advises Small Business Owners and their families, on how to protect themselves, from their businesses.  He writes for successful Small Business Owners and Industry publications. You can read his Modern Small Business Leadership Blog here. You can connect with him on LinkedIn.  Any information provided is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstance.