What is an Offset Account and How Does it Work?

What is an Offset Account and How Does it Work

An offset account is a type of account that can help you take a few years off your mortgage payments. Granted that you use your offset account wisely, you can lower interest payments, build equity in your home faster, and shorten the term of your loan. Let’s talk about an offset account, how it works, and how you can get the most out of it to reduce the amount you owe on your mortgage.

What is an offset account?

An offset account is a type of bank account linked to your mortgage. The money in this account is used to reduce the interest you pay on your mortgage. So, instead of earning interest on your savings, the balance in your offset account “offsets” or reduces the interest charged on your home loan.

It’s just like a transaction or everyday banking account that allows you to save and access your money. However, an offset account offers the additional advantage of helping you save on mortgage interest and potentially pay off your home loan sooner.

Types of Offset Accounts

These are the two main types of offset accounts offered by lenders, and the choice between them depends on your individual financial circumstances and preferences.

Full Offset Account

A full or 100% offset account is a type where the balance in the account is offset against the entire outstanding balance of your mortgage. This means that every dollar in the offset account reduces the interest payable on your entire home loan balance. The full type of offset account is the most common that lenders offer.

Partial Offset Account

A partial offset account is similar to a full offset account but only offsets a portion of the outstanding balance of your mortgage. For example, if you have a partial offset account with a 50% offset, only half of the balance in the account is offset against your mortgage balance.

How does an offset account work?

Here’s an example that lets you visualise how an offset account works. Let’s say you have a mortgage of $500,000. You also have $50,000 sitting in your offset account.

  • Original Mortgage Balance: $500,000
  • Offset Account Balance: $50,000

Because you have $50,000 in your offset account, you’re only charged interest on $450,000. This happens as long as the amount stays in your offset account.

What are the benefits of having an offset account?

Offset accounts offer homeowners a strategic way to manage their finances by leveraging their savings to reduce the interest payable on their home loans.

Unlike traditional savings accounts where interest earned is subject to taxation, funds deposited into an offset account are not considered taxable income. This provides a tax-efficient way to save.

Aside from tax benefits, other benefits of having an offset account include:

  • Interest Reduction – the balance you have in your offset account reduces the interest you pay on your mortgage as it ‘offsets’ your savings against your home loan balance.
  • Flexibility and Accessibility – offset accounts function like regular transactional accounts, allowing easy access to your funds for various financial needs. For example, you decide that you need a new hot water system one day. You can withdraw funds from your offset account to start installing the new water system.
  • Daily Interest Calculation – interest is calculated daily, so even brief savings periods in the offset account can yield interest savings.
  • Higher Effective Interest Rate – even though you don’t earn interest on the money you keep in an offset account, the amount of interest you save on your mortgage is usually more than what you would earn in a regular savings account. This means that using an offset account can be more beneficial financially, as the interest you save on your mortgage is often greater than the interest you would earn by keeping your money in a regular savings account.
  • Multiple Offset Accounts – It’s possible to link multiple offset accounts to a single home loan. This allows borrowers to maximise the benefits of offsetting by leveraging the combined balances of all linked offset accounts to reduce the interest payable on the mortgage.

Offset accounts allow homeowners to optimise their finances, save on interest expenses, enjoy tax benefits, and maintain liquidity for their day-to-day needs.

Maximising Benefits with Offset Accounts for Investment Property Loans

Having an offset account for investment property loans can also be beneficial. When you borrow money to buy an investment property, the interest you pay on that loan is usually tax-deductible. This means you can subtract the interest payments from your rental income when calculating your taxable income, which can lower your overall tax bill.

When you deposit money into an offset account, you pay less interest on your loan, which saves you money.

Even though you’re reducing the interest you pay with the offset account, the tax deductibility of the interest on your investment property loan remains the same. In other words, you can still claim a tax deduction for the interest you pay on the remaining balance of your loan, even if you’re using an offset account.

To put it simply, offset accounts for investment property loans help you save on interest costs without affecting the tax benefits you get from deducting the interest on your loan. It’s a smart way to manage your finances and maximise your tax savings.

What are the risks of an offset account?

While offset accounts offer numerous benefits, there are some potential risks to consider:

  • Higher Mortgage Rates – loans with offset accounts may come with slightly higher interest rates compared to loans without this feature. Borrowers should assess whether the benefits of an offset account outweigh the higher interest rate.
  • Fees and Charges – offset accounts may come with fees and charges, such as account maintenance fees or transaction fees. These costs can eat into the potential savings generated by the offset account.
  • Savings Discipline – some borrowers may find it challenging to maintain discipline with their offset account, potentially using the funds for non-essential expenses rather than maximising interest savings on their mortgage.

While offset accounts can be a valuable tool for managing mortgage interest and accelerating loan repayments, borrowers should carefully weigh the potential risks against the benefits to determine if an offset account aligns with their financial goals and individual circumstances.

How can you get the most out of your offset account?

We have a few recommendations that you can consider if you already have an offset account but would like to make the most out of it:

Put Extra Money into Your Offset Account

To get the most out of your offset account, put any extra money you have straight into it. This is because the interest rate on your home loan is likely higher than what you’d earn in a regular savings account.

Plus, you won’t pay taxes on the interest earned in the offset account like in a savings account. So, by putting your savings directly into the offset account, you’re effectively reducing the interest you pay on your mortgage and saving money in the long run.

Use as a Transaction Account

Consider depositing your salary or income directly into your offset account and using it as your main transaction account. This way, every dollar you earn helps reduce the interest on your mortgage because interest is calculated daily. By depositing your income into the offset account, you keep the balance high, which lowers the interest charged on your mortgage, ultimately helping you pay off your loan faster.

Shop Around for Good Rates

Different lenders offer varying interest rates, fees, and features for their offset accounts. By comparing offers from multiple lenders, you can potentially find an offset account with a competitive interest rate and favourable terms that suit your financial goals.

Is it worth having an offset account?

So, are offset accounts worth having? Yes, they can be if used correctly! They offer several benefits, including reducing the amount of interest payable on your mortgage, providing tax efficiency, offering flexibility in accessing funds, and potentially accelerating mortgage repayments.

By leveraging the features of an offset account effectively, homeowners can save money on interest payments and pay off their debt faster. This makes it a valuable financial tool for managing home mortgages.

Of course, getting a home loan with an offset account feature has risks, so it’s essential to consider potential risks and how to mitigate them.

Borrowers can:

  • Compare offers from different lenders to find competitive rates.
  • Maintain discipline by setting clear savings goals.
  • Choose offset accounts with minimal fees.
  • Diversify savings across multiple accounts.

And, most importantly, you need to carefully evaluate the terms and features of offset accounts offered by different lenders and consider your individual financial goals and circumstances to determine if an offset account aligns with your needs.

Get Better Rates on Your Offset Account

If you’re ready to take the next step in optimising your mortgage strategy, we can help! We are your property and finance experts, backed by decades of experience. We also work with many lenders every day to ensure you receive the best loan product that’s suited to your own individual needs.

Whether you’re looking for competitive interest rates, minimal fees, or flexible access to funds, there’s an offset account out there for you. Don’t hesitate to reach out to us for personalised guidance and assistance. Together, we can help you make informed decisions to achieve your homeownership goals and financial objectives.

Contact us today to see how we can help.