What is Offset Account and how does it work?

With the cost of living steadily growing and interest rates continuing to rise, hundreds of thousands of people across Australia are suffering from mortgage stress, i,e., the pressure to meet their home loan repayments.

Fortunately, offset accounts have emerged as an increasingly popular way to reduce their monthly repayments.

But what is an offset account, and, more importantly, how does an offset account work? Are they as beneficial as they seem, and what are an offset account’s disadvantages? Let’s explore the concept of offset mortgage accounts, as well as their pros and cons.

What is an offset account?

An offset account is a type of bank account linked to your home loan. While a conventional mortgage charges you interest on your entire home loan, an offset account results in you only being charged interest on the difference between your home loan balance and your offset account balance.

Consequently, the higher the balance of your offset account, the interest paid on your home loan, and the quicker you can pay off your mortgage. While offset accounts are typically linked with variable rate home loans, they’re also available for fixed rate home loans.

How does an offset account work, in simple terms?

In short, the money kept in an offset account is counted, or “offset”, against the interest owed on your outstanding loan balance. More specifically, instead of the interest you earn on funds held within the offset account being added to the balance, the interest payments are deducted from your outstanding home loan balance.

Let’s say, for example, that you have a home loan balance of $500,000 but have $100,000 in your linked offset account. Instead of being charged interest on the entire $500,000, you’ll only be charged interest on $400,000 ($500,000 – $100,000). Consequently your mortgage repayments will remain the same, however you will be paying more towards the principal loan and less towards interest.

You can, however, still withdraw money from your offset account, as with any other transactional bank account. Additionally, offset accounts provided by specific lenders work differently, so understanding the terms and conditions is essential to maximise the benefits.

An offset account work compared to a redraw facility?

An offset account is a separate account from which you can deposit and withdraw funds like other transactional bank accounts. Conversely, a redraw facility is a feature attached to your home loan and not a separate account. It allows you to redraw additional payments made on your home loan above your scheduled monthly repayments).

Generally, redraw facilities aren’t as flexible as an offset account, so you can’t use them for everyday purchases or to withdraw cash from an ATM, for example.

See more: How to refinance home loan

Different types of offset accounts

1. 100% offset account: also known as a full offset account, the entire amount held in the account counts against interest paid on the home loan balance. 100% offset accounts are generally associated with variable rate home loans. However, some lenders offer them for fixed rate home loans, although, generally, the terms aren’t as favourable.
2. Partial offset account: these generally work in one of two ways:

Only a portion of the account balance counts against interest paid on the home loan, e.g., a 50% offset, only allows for half of the money in the account to lower reduce interest charged on the principal.

The full amount in the account is offset against the home loan balance but at a lower interest rate. E.g., you’re paying 5% interest on your home loan, but the offset rate is 3%.

The pros and cons of offset accounts

Before using an offset account, make sure you understand all of these aspects and things you should consider to use offset account wisely

Offset account advantages

• Lower interest costs: the main benefit of offset accounts is their potential to save you significant amounts on interest payments over the duration of your home loan.
• Accessibility: offset accounts are flexible, and you can still access the money within them.
• Tax advantages: unlike interest earned on regular savings accounts, the interest earned from an offset account could be tax-free.

Offset account disadvantages

• Higher interest rates: home loans linked to offset accounts may have higher interest rates than other loan options.
• Fees: offset accounts may have additional fees attached
• Minimum and maximum balances: some offset accounts require you to have a minimum balance for the interest to count against your principal. Conversely, there maybe be a maximum amount that you’re able to offset.
• Opportunity cost: keeping funds in an offset account instead of a savings account – or investing it – could result in missed opportunities that would improve your financial situation more.

See more: Mortgage broker vs. Bank

Does an offset account reduce monthly repayments?

Yes, an offset account can reduce your monthly home loan repayments. However, the amount you can reduce your monthly mortgage repayments depends on a few factors:

• Whether its a 100% offset or partial offset account
• Whether you have a variable-rate or fixed-rate home loan
• The balance of your offset account and how frequently you deposit into and withdraw from it
• The lender’s specific terms and conditions for their offset facility

See more: Why you need a mortgage broker?

Considering an offset account? Speak to the team at K Partners, top-rated financial advisers in Melbourne

Whether you’re buying your first home, feeling the stress of the cost of living crisis, or want to refine your retirement savings plan, the skilled and experienced financial advisors at K Partners can help you achieve your financial goals.

We’ll help you evaluate if an offset account is best for your financial situation – or if there are better budgeting and wealth creation strategies that will get you to your desired financial destination faster.

Contact us for your free initial financial consultation.

Please note that all the while the information provided above is factual in nature, it’s also intended to apply generally, and to a broad audience. Subsequently, the information hasn’t taken your personal circumstances or goals into consideration.