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What is an offset account and is it worth getting one?

offset accountDespite offset accounts being around for years, there’s still many home owners who:

a) don’t know about offset accounts; or

b) have an offset attached to their home loan but aren’t using it properly.

 

We want to change that!

Below we explain what an offset account is and how if differs from a basic home loan. We also explain how to determine whether an offset account loan is something you could benefit from.

 

Basic loan vs loan with offset

A basic loan is exactly that – basic. It can either be a Variable Rate Loan or a Fixed Rate Loan, but it doesn’t have fancy features or rate discounts (because the rate is relatively low already). Often there’s a monthly account keeping fee payable.

Basic loans can be a good option if you have a relatively small loan and you want to keep things simple.  For example, you’re keen on maintaining your everyday banking and savings accounts the way they are now (with the exception of making a monthly repayment to your new home loan).

Basic loans work out to be financially advantageous if you don’t expect to be able to build up surplus cash in an offset account and you just want to pay as much as you can directly into the loan itself.

 

Loan with offset account option – “Professional Package”

A loan with an offset comes under a professional package. A professional package is one that can:

  • involve multiple loans (for example you might want to split your borrowing across a fixed rate and variable rate)
  • allow use of one (or even multiple) 100% offset accounts
  • incorporate other lender products – like a credit card, discounts off insurance etc

A yearly professional package fee replaces monthly account keeping fees that can be charged on individual loans/ bank accounts and credit cards. An annual package fee varies between lenders, but is generally up to a few hundred dollars.

Whether you go for a basic loan or a professional loan package depends on two main things.

1. How much you can build up in your offset account (i.e. you want to anticipate enough interest savings from the offset account to warrant paying the annual package fee).

2. Consideration of your long term plans for the property. We won’t go into lots of detail here, but if you intend on moving out of your property at some point and renting it, there’s a strong argument to use an offset account to preserve future deductibility of debt, whilst saving on interest whilst you’re living in the property. You may want to talk to your accountant about this one.

 

How does an offset account work?

Depending on your lender, an offset account works like a normal transaction account. You can deposit and withdraw funds whenever you like via EFTPOS, ATM, internet banking etc.

However because it is linked to your home loan, the balance of your offset account helps to reduce the interest you incur on your home loan.

Instead of earning interest on cash you have sitting in a transaction account, you save interest at the rate you’re paying on your home loan.

The reason this works to your advantage is because the interest rate we pay on our home loans is generally higher than the rate we earn on savings accounts. This means for no additional risk and compete access to your funds at any time – you are saving more interest than you could earn.

Here’s an example to explain.

If your $500,000 home loan was linked to a 100% offset account containing $50,000 cash, the lender charges interest on the net debt you owe (i.e. loan amount – balance of offset account = $450,000)

Let’s say your home loan has an interest rate of 4%p.a, with the rate on an normal savings account being 1.5%p.a. (Please note these are just examples and do not necessarily reflect what you may be able to secure.)

This $50,000 could earn you $755 interest, if it stayed in a savings account for a whole year at a rate of 1.5%p.a.

If this $50,000 sat in an 100% offset account linked to your $500,000 home loan instead, you would incur interest on the net debt of $450,000.  Making Principle & Interest repayments on this lower net debt amount, you would save approximately $1,984 in interest in one year.

If we compare the above options, you have saved $1,229 using an offset account and since you haven’t ‘earned’ any interest, there’s no interest income to report.

It’s important to note you don’t need to keep money ‘parked’ in an offset account to save interest. Most clients use their offset as an everyday banking account, but whilst funds sit there, they’re helping to reduce the home loan interest incurred.

offset account

If you already have an offset account but want to make sure you’re maximising interest savings, read our tips here.

 


 

*Please note this general information is provided as a guide only. You would need to refer to the PDS provided by your lender to ascertain specific information about any products offered by lenders.

 

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