Understand how an offset account works

Understanding how to use an offset account can help you pay off your home loan faster

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?

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It's called an offset account and it could save you thousands of dollars if you use it correctly.

In a nutshell

It's really very simple. An offset account is like an everyday bank 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. This means you pay interest on your home loan balance minus the amount in the offset account.

• Because these savings add up over time, you can also use this 'extra' money to pay your loan off faster. So the higher the balance in your offset, the more you save on mortgage repayments
• Keeping your average balance as high as possible saves you more

Around half of all home loans in Australia have an offset account attached to the mortgage and they are usually only available with a variable-rate home loan.

ProTip: Better quality home loans provide offset accounts on fixed-rate home loans as well.

Here's how it works

Let's say you have a home loan of $400,000 with an interest rate of 6% and you have $20,000 in your offset account. The combined effect of these two linked accounts will be 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 - an offset account, linked to your mortgage.

How easy is it to redraw funds from an offset 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 savings account. You have access to your extra funds at any time (although you'll reduce the amount of interest you're saving if you do).

'Should I save in a savings account or save in a mortgage offset account?'

This is a common question people ask. Think of it like this;

• Everyone has to pay tax on any interest earned on their savings
• Let's say you inherit $20,000 and put that money into a fixed term deposit that earns you 4% interest
• Once you pay tax on this interest you earned, if your personal income tax rate is 32.5% your after-tax (net) return is only 2.7%

That’s probably going to be less than the interest you’re paying on your home mortgage. If it is, perhaps your money will work harder for you in your offset account.

Every dollar you have in your offset account 'offsets' the balance of your loan – reducing the amount of interest you pay every month

What to look for in a high-quality mortgage offset account?

Not all offset accounts are the same, so make sure you check the details.

Make sure you look for:

• a 100% full offset account (rather than a partial offset)
• no minimum balance limit or penalties for withdrawal
• an offset account that can also work with a fixed rate home loan

What's the main 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. An offset account is a linked savings account that uses its daily balance to reduce the daily interest calculation in a linked mortgage account.

Requesting a redraw from a mortgage account might take a few days to process so it can help fight the temptation for a quick purchase.

• You'll effectively save the same amount as with an offset, but you usually don’t have immediate access to your savings
• You'll also be increasing your equity (ownership) in your home because you're paying off the principal

Good quality home loans offer both offset and redraw options so work out which one works best for your personal money style and use the one that works the hardest for you.

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.