What’s an offset account?
An offset account is a bank account that is linked to your home loan. They generally have all the features of an everyday transaction account. The major difference is that it can reduce the amount of interest you are charged on your loan.
Let’s take a look at how they work:
The interest calculation for your loan is typically based on the remaining loan balance at the end of each day.
However, if you have money in an offset account, interest is calculated on the loan balance LESS that amount.
So, if your loan balance is $300,000 and you had $20,000 in an offset account, interest would be calculated on $280,000 instead of $300,000.
Offset accounts are also described as tax-effective, because the reduction in interest charges is not considered to be income for tax purposes. This means you receive the full benefit of the interest savings, without tax.
By comparison, if you invested the same $20,000 in an account that was not an offset account, you may have to pay tax on the interest.
Another attraction with offset accounts is that the interest savings are typically higher than the interest earnings with deposit accounts. This is because the borrowing rate that banks apply to loans is higher than the interest rate they pay on deposits.
So, saving 4.00% on your borrowing rate with an offset account is much better than earning 2.00% on a deposit account, on which tax is generally payable.
Offset accounts are not without costs. They often come with a monthly or annual package fee. For that reason, you need to ensure the interest savings you might make from the funds you think you will be able to retain in the offset account are sufficient to justify the fee.
The offset can be full or partial.
A full offset means that for every dollar in your offset account, the balance on which the bank calculates interest is reduced by a full dollar.
A partial offset means that for every dollar in your offset account, the balance on which the bank calculates interest will be reduced by less than one dollar.
As an example,
$1,000 in a full offset account will offset your loan balance by $1,000.
$1,000 in a 40% partial offset account will only offset your loan balance by $400.
Most variable interest loan offset accounts provide a full offset.
Most fixed interest loan offset accounts only provide a partial offset.
In order to fully utilise the capabilities of your offset account you should consider the following:
- Direct salary to your offset account:
This way, your offset account increases every time you are paid salary, which reduces the amount of interest you are charged. Even if the funds are only held in the account for a couple of days, there is still a benefit.
- If your bank allows it, set up multiple offset accounts
This allows you to separate your transaction and savings accounts and get the benefit of the offsetting loan interest charges on both.
- Select the offset account as the home loan direct debit account:
This ensures repayments are debited from your offset account, which means you receive the benefit of the offset for as long as possible before the payment date.