What is an offset account?
An offset account is an everyday transaction account typically linked to a variable rate home loan. Like your classic savings account, you can withdraw or deposit funds at any time with no penalties, have a debit card and there are no minimum or maximum balance requirements. Any decent lender worth engaging should offer an offset account as part of their variable rate home loan package.
Here’s where it gets more interesting, and to us finance folk, exciting.
Every dollar you have in that account is ‘offset’ against the balance of your home loan, meaning the bank will only charge interest on the difference. For example, your home loan balance is $450,000 and you deposit a lump sum of $50,000 into your linked offset account. The interest will be charged on the difference of $400,000 as the amount in your savings account is offset against the balance owed.
Do you need an offset account?
Absolutely. It’s an incredibly useful tool to save on interest charged on your loan, particularly when interest being earned on cash products (such as savings accounts and term deposits) is very low. More on this below.
Why should you have an offset account?
If used correctly, your offset can potentially save you thousands of dollars while also reducing the overall term of your loan. In short – your home is paid off quicker and for less. Our advice to all our clients, regardless of the size of their loan or savings, is to put your hard earned cash into one or more offset accounts.
Your money works harder for you in an offset account
Unlike a high-interest savings account, you don’t earn interest on the balance of your offset account. We understand this may seem counterintuitive when you’re saving for a home or any substantial life investment. However, we are yet to see any traditional savings account perform better and be more advantageous than an offset account. And here’s why, lenders fund mortgages from savings accounts so interest rates on those accounts are always lower than those of home loan rates.
For example, the average standard variable rate across the big four banks moving forward will be 4.73% (CBA – 4.80%, ANZ – 4.64%, NAB – 4.65%, Westpac – 4.83%). This is based on a principal and interest home loan and is subject to change at any time. Whereas the average term deposit interest rate is sitting at around 0.43% across the market.
With interest on savings products sitting below the current rate of inflation, it doesn’t always make sense to have the cash “earning” interest in your savings account. It could potentially earn you more through interest saved on your home loan!
This means you are reducing the interest charged against your home loan at a much higher rate, than you’d be earning in a traditional term deposit with the same funds. And to top it all off, there are also the potential tax benefits. You pay tax at your marginal tax rate on any interest earned in savings accounts, however funds kept in an offset is not considered taxable income and you certainly aren’t taxed against interest saved on your home loan repayment.
How does an offset account work?
One of the many benefits of an offset account is its flexibility. You have access to your money when and if you require it – no need to wait until the end of the term deposit. However, the more money you can save and add to your offset account, and the longer you can keep it there, the lower the interest charged on your home loan balance will be. So regardless of the amount you manage to put away, you are always ahead with an offset.
Here are some key ways to maximise the benefits an offset account:
- Deposit all your savings into your offset. Interest rates are calculated on a daily basis which is why it’s wise to put any excess cash into the offset. Even if the balance fluctuates with your transactions, remember – every dollar counts.
- Deposit your salary into your offset account. Why not have your employer pay your salary into your offset. Even if you then need to withdraw funds to use for other expenses, the money left in there is still working for you.
- Set up multiple offset accounts. Some lenders will permit you to link multiple offsets to your home loan. This may help you keep your various saving goals separate and trackable (your wedding, holiday, those school fees) but each account balance contributes to the overall reduction to the interest and lifespan of your loan.
- Use your credit card to your advantage. If you can pay off the full balance of your credit card when it’s due within the interest free payment period, then a great trick is to use credit for every day transactions thus leaving more savings in your offset for longer. But be careful. Credit card interest rates are significantly higher than your home loan so discipline is required to ensure this is paid off each and every month.
What are the risks of using an offset?
We clearly sing the praises of offset accounts, however not all lenders are created equal and some may have different terms and conditions. It is important to be aware of the potential pitfalls and risks associated with an offset account so together we can carefully crunch the numbers and determine the right loan package and strategy for you.
You need to consider:
- Offset accounts may incur additional and higher fees.
- Home loans linked to one or more offset accounts typically incur a higher interest rate.
- Given these additional costs, offset accounts are most worthwhile when there is a substantial balance in the account. Spending restraint needs to be exercised to reap the full rewards!
- Ensure your account is a 100% offset and not a partial offset which only offsets your savings against a percentage of the loan.
For more information regarding offset accounts or to have a discussion with our friendly team of brokers, get in touch.
What is a redraw facility?
A redraw facility is different to an offset. When you make extra repayments on your home loan above the minimum required, you are essentially ahead of your loan repayments. Some lenders will then back this extra balance available to you to redraw.
A redraw is a feature that allows you to take back extra payments that you’ve made on your loan. If you are ahead of your loan repayments, the balance of your loan is lower and you will be charged less interest accordingly. If you only make the minimum repayment each month then you won’t have anything available to redraw.
Something else to note is that lenders are in control of how much you can redraw and may set limits or reduce redraw options available. A few years’ back one lender came under fire when they absorbed all redraw balances on all the home loans on their book, loan balances were reduced accordingly but the redraw facility dropped to zero.
How do they differ?
An offset account is a separate banking account you need to open (and potentially pay fees on), which allows you to deposit and redraw funds at any time.
A redraw is a feature on a home loan that lets you effectively increase your loan balance (up to a limit) if you have made extra repayments on the loan.
You can’t use funds on your redraw via your debit card and will reduce in availability over time as it’s calculated based on the loan amount, repayments that should have been made and the term of the loan.
Which is the best option for me?
We always suggest speaking with a broker or lender about what products and features you need before making a decision regarding your finances and lending options.