What is offset account and how does it work

An offset account is one of the best tools an investor or an owner occupied home owners can have in his/her arsenal. Used properly, it can knock thousands off your loan amount, saving you a great deal of interest in the process.

What it is

An offset account is a savings or transaction account that is tied to your mortgage. As the name implies, the balance in your account is ‘offset’ against the balance on your loan, reducing the interest calculated against it. For example, if you have a loan for $200,000 and you have $25,000 in your offset account, then interest on your loan is only calculated at $175,000. Any interest that you earn on the funds in the account is also applied against your mortgage, reducing the interest you pay even further.

Other benefits

Unlike a regular savings account, you don’t pay tax on the interest your offset earns as it goes straight into your loan balance.

What to look for

Not every offset account is alike. To help maximise the benefits of an offset you want maximum flexibility. Features to look for:

100% of the money you deposit into the account is offset against your loan.
Interest is calculated daily on the entire balance of your account.
No limits on the amount you can deposit in the account.
No limits on money you can withdraw from the account.
Interest is earned at the same rate as your mortgage interest rate.
Interest you earn follows with any increases in your mortgage rate.
Zero to low transaction fees.
A low interest credit card is included with the loan. The rate should be much lower than a typical credit card and include a 45 day free interest rate period.

Benefit of an offset

Pay off your loan more quickly
Earn interest at a better rate than ordinary savings account
Reduce the interest you pay
Ability to access funds if needed

How to maximise your offset account

The following strategy requires a good bit of financial discipline. Each payday put your entire cheque into your offset account. Now you can either pay your bills out of this account or you can take it a step further and use a credit card instead.

Make sure the card you use has a 45 day grace period for all of your living expenses and then pay it off in full from the funds in your account. While your money was sitting in the account the interest that accrued against the balance helped to reduce the interest you’ll pay on the mortgage.

How much faster could I really pay down my loan?
As an example, let’s say you have a $200,000 home loan and you’re paying an interest rate of 6% over 30 years.

The interest you would pay without an offset loan over that time period (assuming no rate changes) is over $231,000.

If you’d had tucked away $20,000 in your offset account (and kept it there) you would have paid about $40,000 less AND shaved more than 5 years off your repaying schedule.

As you can see, an offset account, when managed properly, can be a fantastic tool for investors to create wealth.