What is an offset account and how does it work?
An offset account is a transaction or savings account linked to a home loan, designed to reduce the interest payable on the loan by offsetting the balance in the account against the outstanding loan amount. Here’s how it works and the benefits it provides:
How an Offset Account Works
- Linked to Home Loan: The offset account is directly linked to your home loan. The balance in this account offsets the loan balance for interest calculation purposes.
- Interest Calculation: Instead of paying interest on the full loan amount, you pay interest on the loan amount minus the balance in the offset account. For example:
If your home loan balance is $500,000 and you have $100,000 in your offset account, you will only pay interest on $400,000. - Everyday Use: You can deposit your salary, savings, or other funds into the offset account and use it like a regular transaction account. This includes making withdrawals, paying bills, or making purchases with a linked debit card.
Types of Offset Accounts
- Full Offset Account: The entire balance of the offset account is used to offset the home loan balance. This is the most common type.
- Partial Offset Account: Only a portion of the balance in the offset account is used to offset the home loan balance. For example, a 50% partial offset means if you have $50,000 in the account, only $25,000 is considered for offset purposes.
Benefits of an Offset Account
- Interest Savings: Reduces the amount of interest payable on the home loan, which can lead to significant savings over the life of the loan.
- Flexible Access: Provides easy access to your funds, allowing you to use the account for everyday transactions while still benefiting from interest savings.
- Reduces Loan Term: By reducing the interest payable, more of your repayments go towards paying down the principal, which can shorten the loan term.
- Tax Efficiency: Interest savings are not considered taxable income, making it a tax-efficient way to manage your mortgage and savings.
- Encourages Savings: Encourages better cash flow management and savings, as keeping a higher balance in the offset account where possible leads to greater interest savings.
Considerations and Potential Drawbacks
- Account Fees: Offset accounts may come with additional fees, such as monthly account maintenance fees or higher loan interest rates, so it’s important to compare these costs against the potential interest savings.
- Discipline Required: Effective use of an offset account requires financial discipline to maintain a higher balance in the account to maximize interest savings.
- Not Always Available: Not all home loans offer an offset account feature, particularly basic or low-rate loans, so it’s important to check with your broker.
