How 100% offset accounts work
Offset accounts can be excellent for reducing the time it takes you to pay off your mortgage and can save you tens of thousands of dollars in interest.
Offset accounts explained
When you set up your mortgage, some lenders will offer you the option of an offset account. Like the name suggests, an offset account involves your savings compensating for a portion of the amount that you borrowed.
Offset home loans comparison
By leaving your money in an offset account, you have the opportunity to save far more in interest charges than you could potentially earn in interest payments.
Heidi Armstrong, Director of State Custodians Mortgage Company says that offset accounts are no more complicated than a regular transactions account. ‘An offset account is like a transaction account that can be linked to the loan. It may even be a separate sub account or portion of the loan. Instead of receiving interest on the offset account balance, those funds are 100% offset against the daily balance of the nominated loan portion.’
100% offset accounts
If you owe $200,000 on your mortgage and you have $20,000 in savings in your offset account, your interest will be calculated on your mortgage balance, minus your savings balance. This means you're only paying interest on $180,000 instead of the full $200,000 that you owe.
|With an offset account, you only pay interest on||$180,000|
As your savings grow, the amount you save on your interest bill also grows. Effectively, this reduces the amount of interest charged on your mortgage statement. When you consider that your repayment amount doesn't change, this allows you to pay more of each payment directly off the principal amount and less in interest costs each month.
Earning interest on savings?
While it's true you're not earning any interest on the money you leave in your offset account, you're actually gaining more than you lose. In most cases, the interest you'd be earning on your savings is lower than the amount you're charged on your mortgage. You'd also be paying tax on the amount of interest you earn, so it's reduced even further.Back to top
How mortgages benefit from offset accounts
Every repayment you make to your mortgage is comprised of a principal portion and an interest portion. This is because your mortgage payments are reduced which means they're calculated to ensure you pay off your loan over the total loan term, as well as paying your interest charges. As your level of savings increases, the interest that you need pay decreases.
Assume your regular mortgage payment is made up of 90% interest payment and 10% going towards paying down your home loan balance. If you have savings in your offset account, those ratios alter so you're paying a smaller portion in interest and a larger portion on the principle balance every month.
|Loan Amount||$250 000||$250 000|
|Time Saved||-||2 years, 10 months|
Obviously this has the effect of paying off your home loan much faster as your savings grow. You're also drastically reducing the total amount of interest you'll pay over the term of your mortgage.
Maximising mortgage benefits from offset accounts
Disciplined customers can maximise the effect that offset accounts can have on reducing their mortgage quickly in several ways.
This is simply an option to maximise the benefit of having your savings offset against your mortgage. If your credit card offers interest free days on purchases, this allows you to pay for your expenses and bills at the beginning of the month and leave your entire income sitting in your offset account. During that month, you pay no interest on your credit card debt, but your income is having the effect of offsetting your mortgage interest for a longer time, as it's sitting there untouched for that month. When your credit card bill is due, you simply transfer your money out of your offset account and onto your credit card so it's paid off in full. Because your credit card has interest free days, you don't have to worry about interest payments on that account at all.
If you don't think you'll remember to pay your bill before the due date, or if you don't want to risk it, you can ask your bank to set up an ‘auto-sweep’ option.
An 'auto-sweep' is when your bank automatically sets up a direct payment into your credit card account from your offset account for whatever amount is needed to pay down your balance to zero before the due date. You're guaranteed never to miss a payment and you don't have to try and remember due dates. It's all done for you.
If you're careful about spending less on your credit card than the amount you earn each month, you'll find that your savings will grow over time so the benefits you receive keep increasing.
Dangers of offset accounts
While it sounds relatively simple, an offset account can have drawbacks for some customers. This is especially true for those customers who choose to use the credit card option in conjunction with offset accounts and mortgages.
If you don’t use the credit card option and just accumulate the savings in your offset account, you will find that the amounts you pay interest are slowly reducing. But the temptation to spend more on your credit card than you earn is very high for some people. It's very important that you control your credit card spending to add up to less than the amount you earn.
This is because your income will be used to auto-sweep your credit card bill at the end of the month. If you don't have enough funds in that account to pay off the whole balance in full, you will retain a balance on your credit card that will immediately begin attracting interest at a very high rate.
On top of this, when your offset account is cleared to pay off your credit card, you risk your account being overdrawn, or simply being emptied. This negates the value of having an offset account at all if it's empty.
But if your lender decides to overdraw your account, you could be hit with overdrawn fees, as well as hefty interest charges on your credit card account. If you really don't feel that you have the discipline to keep your credit card spending under control or if you think you'll spend more than you earn, an offset account is not recommended.Back to top
How does a partial offset account work?
A partial offset account behaves similarly to an 100% offset account but only some of the interest is charged on your home loan, rather than the whole amount. It can also be explained as a savings account where the interest generated by the offset pays off the principal in the loan, without the borrower having to pay tax on the interest.
With a partial offset account linked to a home loan with an 8% interest rate, if you had a loan of $300,000 and a balance of $10,000 in your partial offset account, your $10,000 balance may only be earning 6% interest.
|Interest rate paid on loan||8%|
|Partial offset account||$10,000|
|Interest rate earned on partial offset account||6%|
This means that you are still paying 8% interest on $290,000 of your loan, but only 2% interest on the remaining $10,000 of your loan, as this $10,000 is offset by the 6% interest earned on the balance of your partial offset account.
|Interest rate paid on loan||8% on $290,000|
|Interest rate paid of partial offset||2% on $10,000|
|Interest rate earned on partial offset||6% on $10,000|
While a partial offset account saves you interest and time in repaying your mortgage, it is not going to be as effective as a 100% offset account. Unfortunately some Australian lenders only offer partial offset accounts and are yet to add 100% offset accounts to their loan features and if the lender who can approve the loan amount you need, with the remaining loan features you want only offers a partial offset account, then there is little point choosing a different loan with a 100% offset account, if it is not the right loan for you.
Keeping account fees down
One problem some customers may face when setting up offset accounts is high account fees.
Warning! Watch out for Account-Keeping Fees.
You might be paying a $10 monthly account fee on your mortgage, a $10 monthly account fee on your offset account and a $175 annual fee on your credit card. Some banks may even charge transaction fees on your transaction account as well.
|Monthly Account Fee (mortgage)||$20,000|
|Monthly Account fee (offset account)||$180,000|
|Total (for a 5 year loan)||$2075|
This can really add up and eat into the interest savings you thought you were making. It's important to negotiate with your current lender for lower fees or shop around and compare what other lenders are willing to offer you.
Some banks may offer package deals where they'll waive the account fees and reduce the annual fee if you accept the entire package of financial products. These are sometimes called ‘professional packages’ and often charge one simple annual fee for everything you have within that package. All together, it is usually cheaper than the individual fees charged on the same accounts.
Also, consider splitting up your products between different lenders to minimise fees. For example, the Bankwest Easy Transaction Account is a completely fee free banking when you deposit at least $2,000 per month. If you have more than one transaction account or if you and your partner have different accounts, then this account is perfect for consolidating all your funds.Back to top