Have you ever walked away from a meeting with a banker or mortgage broker and wondered “How does a mortgage offset account work?” Don’t worry, you aren’t the first and certainly won’t be the last person to have wondered what this strangely named bank account is, and why you are being offered one.
Almost all major home finance lenders in Australia offer a mortgage offset account, often as part of an overall package, meant to lure you into borrowing with them. We’ve written an article about how to make the most of these packages (and your transactional banking) before, but today we are taking a step back and explaining in simple terms, how a mortgage offset account actually works.
How A Mortgage Offset Account Works
Put quite simply, an offset account is a normal everyday transaction account. They normally have debit cards, low or no fees and quite literally operate just like your normal everyday banking account. However, unlike normal transactional accounts, this account actually puts the balance of your funds to work for you.
The balance in your mortgage offset account directly offsets your mortgage balance with regards interest calculations on your home loan. It’s definitely easiest to understand with an example.
You have a home loan with a balance of $400k. You have been a great saver and have saved a balance of $65k in your offset account (Bravo…you’re doing better than many Australians). Without an offset account, your monthly payments to the bank would be based on interest on the full $400k…however with an offset account, your payments are calculated on a reduced balance as following:
- $400k – $65k = $335k
If your loan is an interest only loan, your monthly payments will reduce because you are paying interest on only $335k, not $400k. The big gains however, are found when you are paying principal and interest. Your monthly payments remain the same, but because you are now paying interest on a lower balance due to the offset, the proportion of your monthly payments going towards paying off your actual principal balance increases and the proportion paying interest decreases.
Example Of Savings
In the short term, this might not seem like such a big deal, especially because you aren’t seeing more money in your hand each month, but using Westpac’s Home Loan Offset Calculator we can show you just how huge the savings can get. Using an interest rate of 5.68%, a loan term of 30 years and the assumption that we had $65k in the offset account from the start of the loan, the results are staggering.
The loan term reduced by a whopping 7 yrs and 3 months (down to just 22 yrs and 9 months) and the interest paid over the life of the loan nearly halves, saving you just over $203k. Yes you read that correctly… a saving of over $203k over the life of the loan. We recommend playing with the calculator and working out just how much you could save.
The saving made on offset accounts look even more enticing when you consider they are tax free. When home loan rates are high, it makes this strategy even more appealing because achieving such great after tax returns elsewhere are often quite risky.
So there you have it…you now have an answer to the common question “How does a Mortgage Offset Account work?” We hope you enjoyed the read…feel free to fire any further questions away in the comments section and we’ll do our best to answer.