Offset accounts: what is an offset account and how do they work?

So you’ve heard about this thing call an offset account and got wondering… what is an offset account? How does it work? Does it actually help you to pay down your home loan faster? What are the benefits of an offset account? And the drawbacks? How is an offset account different to a redraw facility? And, are they even worth it?

The truth is – offset accounts aren’t that mysterious. And they can be super helpful. So we’ve broken down what you need to know.

What is an offset account?

An offset account is a bank account that’s linked to your home loan and works exactly as a normal transaction or savings account does – but it has the added benefit of also “offsetting” the interest you pay on your mortgage.

That is – the funds held in your account are applied against your home loan balance and you’re left paying interest on the difference only.

To illustrate: if you have a $400,000 home loan with a 4% interest rate, you would need to pay $1,333 per month in interest ($400,000 x 4% / 12 months = $1,333 per month).

Now, if you also had $100,000 also sitting in an offset account, it would offset your loan balance to $300,000 and in turn, reduce your repayments to $1,000 per month ([$400,000-100,000] x 4% / 12 months = $1,000 per month).

What are the benefits of an offset account?

Offset accounts have a number of benefits. They can:

• Reduce your interest payments
• Allow you to pay off your loan more quickly
• Offer potential tax benefits
• Allow you to put a dent in your debt, whilst giving you access to the cash in your offset account, anytime you need.

The first point is the most obvious benefit – the bigger the balance in your offset account, the less interest you have to pay. Win!

Additionally, if you keep making your usual mortgage repayments at the same time as stashing away spare cash in your offset account, you chip away at your principal and can pay down your loan even faster.

There are also some potential tax benefits of an offset account – predominantly that your offset account’s interest benefit is not considered taxable income. It’s important to discuss potential tax implications with your accountant or financial adviser before you sign on the dotted line; especially if your loan is for an investment property or a principal residence that you may wish to rent out, one day in the future.

An offset account is also super handy because you can put your money to good use (e.g. reducing your interest) but also have your money readily available to you, should you need the cash.

What are the drawbacks of an offset account?

Despite the many benefits of an offset account, they also can have some drawbacks or things to look out for. The potential drawbacks of an offset account include:

• Higher account fees
• Higher interest rates on your loan
• Initial deposit or minimum balance requirements

Because of its benefits, a loan with an offset account may attract higher account fees and/or loan interest rates when compared to other products (like those that offer redraw facility only or low introductory rates). That said – the difference may well be well worth it. But it’s important to do the sums to make sure things add up in your favour!

Offset accounts can also come with some special conditions. For example, you might be required to make a large initial deposit. Or you may need to maintain a minimum balance in the account, in order to make the higher fees or rates worthwhile.

If you’re pretty disciplined when it comes to your money, an offset account can be a great tool. However, it is unlikely you’ll get the most out of this account if you routinely withdraw more than you deposit. So it’s important to get your cashflow and spending habits in order first.

What is a redraw facility?

Unlike an offset account, a redraw facility isn’t its own bank account. Rather it’s a feature of your home loan that permits you to withdraw from your loan, if you’ve kicked in funds above and beyond your scheduled payments.

Like an offset, a redraw facility allows you to reduce the amount of interest you’re paying. However, a redraw can be a bit less flexible. For example, the redraw isn’t an account, so you won’t have features like separate online logins or linked bank cards that allow you to withdraw funds from an ATM.

It’s also up to your lender to decide whether they’ll allow you to redraw. The reality is they’ve loaned you money, and you’ve repaid a portion of your loan to them. So, when you request a redraw, your lender will need to decide whether they’ll allow you to ‘reborrow’ funds via the redraw facility. No guarantees!

In summary.

Offset accounts are bank accounts linked to your home loan that:

• operate like a typical savings or transaction account;
• give you access to your money any time; and
• calculate the monthly interest owing on your home loan as:
  (Mortgage Balance – Offset Account Balance) x Interest Rate / 12 months

Redraw facilities are features of your home loan that:

• may allow you to re-withdraw funds you’ve paid against your mortgage, above and beyond your scheduled repayments

Both offset accounts and redraw facilities allow you to reduce your interest and speed up paying off loans. An offset account and redraw facility can be used in tandem to give you extra bang for your buck.

To offset or not to offset.

Well now you know more about offsets, including some of the benefits and drawbacks of an offset account.

Whatever you decide to do, it’s important to weigh up your options and consider your personal circumstances.

We always recommend working with a team of professionals who understand the interconnected nature of your personal finance and tax situation (and if you have one, your business). It’s here where all the mucky mistakes happen. That’s why we work as Integrated Advice Teams – to ensure we’ve got you covered.