Offset accounts are nothing new to banking, however it still surprises me to see how many people with home loans still do not know what an offset account is or how it works. Before explaining the key benefits, I’ll explain how the offset account works and then we’ll look at why you potentially should have one.
One hundred percent offset accounts work on the basic principal that every dollar in your normal everyday bank account, is deducted from the balance of your home loan for the purpose of calculating your daily interest owed. Your loan balance does not change, but the proportion of that balance charging interest is reduced by the balance of your everyday transaction (offset) account.
Bob has a home loan of $300 000, and has cash savings of $50 000. For a number of reasons, Bob doesn’t want to put all of his cash directly onto his home loan, so he opens an offset account. Instead of paying interest on $300 000 (calculated daily but paid in monthly), he only pays interest on $250 000. If Bob is paying interest only on this loan, the monthly repayments are reduced. However if Bob is paying principal and interest, the result is a larger proportion of his monthly payments being used to pay down principal on his loan. In either situation the result is still large savings in interest.
Based on the above scenario, if Bob’s loan term was 30 years he would save an estimated $240 300 in interest over the term of the loan and would pay the loan down in only 20 years and 5 months. It is worth searching the web for offset account calculators to find out your potential savings if your not offsetting your loan already. Most bank website will offer a calculator, for this piece I used ANZ’s 100% Mortgage Offset Calculator.
You may ask why would someone not simply pay more money directly into the loan itself for the same result. This is a valid argument and for many it is just as good a strategy, as long as the loan has a redraw facility so you can access your funds should you need them in the future. For some however, having the loan limit stay high but still make savings using an offset account is a better option. Those with uncertainty regarding using the property for investment purposes in the future are one example where this might be the case. Being able to pull money directly out of the offset account for a deposit on a new live in home, whilst keeping a high limit for the existing loan which turns into an investment loan would have potential tax advantages.
The taxation benefits of offsetting your loan as opposed to earning interest on your savings is another benefit. If your loan is charging 7.5% interest and your cash savings account is earning 6.25%, the return/saving from the loan is 1.25% higher to begin with. When you factor in that Australian’s pay tax on interest earned from savings, the gap between their real return is widened as your interest savings on the loan are tax free. (This again can be achieved by simply depositing your funds directly into your home loan but it is certainly important enough to gain a mention in this article).
Before making any changes to your banking, ensure you pay a visit to your local banking specialist for professional advice regarding whether this strategy is correct for your circumstances.