A common feature that is touted to save you money on your mortgage is that of an ‘offset account’. An offset account is linked to your mortgage and helps you reduce the amount of interest you pay, in turn letting you focus on repaying the principle (the actual debt) as fast as possible.
It must be known however that using an offset account, while ideal for some, can also be a waste of time for others. It all depends on your individual circumstances and of course your ability to maintain discipline in your quest to pay off your mortgage.
This guide will explain to you what you need to know about mortgage offset accounts and how they can save you money when used correctly.
How an offset account works to save you money
An offset account ‘offsets’ your savings against your debt, meaning you only pay interest on the debt less your savings. This equates to less interest payable on your debt as your savings are reducing the principle amount you owe on any given moment.
As you know, a mortgage is comprised of two components; the amount you originally borrowed (the principle) and the interest you are charged for borrowing that money (often a percentage of the outstanding debt).
Now most people have a single goal when it comes to a mortgage; repay it as fast as possible and “get the bank off your back” as many Australian’s would say.
This goal is often excelled by paying as little interest as possible, using a mortgage offset account as a tool by which to speed this process up.
Reasons to consider an offset account
Now before we go on to explain the offset account in detail; here are some of the top reasons you might be exploring the use of an offset facility.
- Every dollar you have in the account will work towards repaying your mortgage faster.
- You don’t pay tax on any interest you save.
- Your savings are working to repay your home loan faster.
- Your money is easily accessible.
- You can withdraw the money to maximise your negative gearing if you buy another property later on.
- It can help uncomplicated your finances by having one account.
An example of a mortgage without an offset account
Imagine you have a mortgage of $500,000 and a high interest savings account with a balance of $5,000.
In this scenario, you are paying interest on $500,000 in debt while earning interest on $5,000 in savings.
The problem this creates is that you are paying interest to the bank, while earning very little interest on your savings (plus you will then be further taxed on the interest you have earned, making the net result rather pointless).
While savings accounts are useful for motivation, goal setting and just generally saving money; your money isn’t working as hard as it could if you do indeed have a mortgage with an outstanding balance.
An example of a mortgage WITH an offset account
Now say you had a mortgage of $500,00 with an offset account attached. You could then store your $5,000 in savings within this offset account and only be charged interest on your mortgage less your savings, in this instance; $495,000 instead of $500,000.
You not only pay less interest, but you are not required to pay tax on the savings, meaning more money saved to benefit your overall financial position.
The tax benefit of using an offset account VS a high interest account
As mentioned above, there is an inherent tax benefit to using a mortgage offset account in most scenarios.
When you earn interest via a high interest savings account, the rate you earn at will be less than what you are charged on your mortgage. This means the banks make money on debt and pay a little money back via earned interest; this leaves you with a shortfall.
Also, any money you do earn is classified as income by the tax office. This means that if you were to earn $250 a year on your $5,000 in savings; the tax office will grab that $250 and take a percentage of it, depending on your individual tax rate it could be nothing or up to nearly 50%.
So while a mortgage offset account doesn’t earn you interest, you will instead be saving interest, which is as good as money in your pocket – albeit tax free.
Things to watch out for when it comes to offset accounts
While paying less tax and reducing the interest on your home loan may sound fantastic, there are a few things you must watch out for when it comes to using such a facility.
Offset account features often cost money. Many lenders will charge a fee or give a less than ideal interest rate in exchange for the use of an offset account.
You must remember to do the maths to be sure that an offset account, even with the cost associated, will indeed save you money. Quite often you will need to have a sizeable amount of money in your offset account to simply balance out the fee charged.
In saying this, many home loans these days come with built in offset accounts or redraw facilities at little to no cost; it’s just a matter of comparing lenders properly.
Offset accounts create the temptation to withdraw money. Having your savings so easily accessible means you must uphold the utmost discipline with your strategy. All too often people want to use an offset account but in reality lack the discipline to keep money in the account and make it worth their while.
A common strategy to use with your mortgage offset account
Given that any money stored in your offset account is saving you interest, people tend to put their entire pay cheque into the offset account and have their debits and expenses extracted directly from this account.
For example, the $50 you have allocated to paying the gas bill each month is helping you pay less interest between when you save that money and when the bill is actually due. Every dollar in the account is contributing to your savings.
This strategy basically involves keeping all available funds inside the offset account until they are needed; this way your money is working hard for you at all times. This is especially great given that sometimes we get paid monthly and have hundreds, if not thousands of dollars sitting idle for up to 20-30 days.
Offset accounts are also beneficial for property investing and negative gearing
I won’t go into too much detail, but a strategy that many people use is this. If they have a house currently, and one day intend to rent that house out and perhaps buy another property, they will maximise how much cash they have in their offset account by paying interest only and offsetting the principle component of their repayments, as come time to rent the place; they want to increase their interest charges by removing the cash onto their other loan, in turn making a larger debt to enhance their negative gearing strategy on the original property.
This means you can claim more interest in your investment property and use your old offset savings to pay less interest on your new primary property.
How do you go about getting a mortgage offset account?
You can use a mortgage broker. Given that you will need to asses whether or not an offset account will indeed save you money; it is suggested that you work with a mortgage broker to find lenders that offer this feature and help do the maths to ensure it will be beneficial.
You can compare lenders yourself online. For those a little more confident, you can search online yourself. Like any other loan you are basically looking for the best comparison rate, the lowest fees and the greatest features.
Tell us how you use your offset account below
Do you have any offset account tips that might save others more money? Share them in the comments below.