Simply put, an offset account is an account, or set of accounts, attached to your mortgage, when you finally have the pleasure of owning a home or investment property.
You can use a single offset account but most banks sell packages, for an annual fee, that will provide you with several offset accounts should you choose to use them. There are also home loan packages that do not contain offset accounts.
Yes, yes, I understand that I still haven’t explained how an offset account actually offsets anything but bear with me as I unfurl everything there is to know about the purpose of offset accounts and the associated advantages and disadvantages.
Here we go.
What The Heck Are Offset Accounts? Why Do I Need One?
Most people use offset accounts as savings accounts within the structure of their loan. You can have an offset account for travel, an offset account for renovations, even your unborn child’s future education, the point being that any amount of money kept in these linked accounts subtracts the amount held in that account from your mortgage and therefore the interest the bank is charging you on the remaining amount of the said mortgage. Pretty straightforward, huh?
However you may have noticed, now that you are a fully fledged adult, that nothing in life is ever particularly straightforward. I imagine that’s why you’re reading this article?
It is your choice what type of home loan you want and you can discuss this with your lender once you have secured your property, but going in armed with as much knowledge as possible will stop you looking like a possum in the headlights when faced with the myriad of choices they will confuse you with regarding the structure of your home loan.
Buying a home is exhausting and at this stage of the process, you just want the paperwork behind you and the keys in your hand. That being said, don’t fall at this final hurdle — there are savings to be made! — so pay attention.
Now that we understand what an offset account is, it seems like a no-brainer to have one or many. Why wouldn’t you want accessible savings reducing the amount of interest you are paying on your loan?
To offset or not to offset, that is the question.
The Disadvantages Of An Offset Account
We always want the bad news first right?
Well, for starters, you are making an overall saving over the life of your loan (advantage) but the money sitting in your offset account won’t make a lick of difference to the amount you are paying on your weekly, fortnightly, or monthly repayments as the money in your offset account only contributes to the principle amount owing and not the interest.
As a rule, loans containing offset accounts are more expensive than your simpler “bread and butter” type loan. Attached to this magical idea of reducing your mortgage come provisos, which vary from institute to institute. These caveats generally have to do with limits on monthly deposits and withdrawals as well as your ability to change the structure of your loan within the yearly period after paying the fee.
Banks sell these types of loans with jazzed up names to get you are on board but as the old adage goes: “Never trust a book by it’s cover.” It is the same with your home loan and you need to establish early what you are signing up for.
It is not only an annual fee that may cause an issue: there are also rules around fixed verses variable interest rates attached to offset accounts. In order to fix a low interest rate on a property, you also forfeit the entire amount held in your offset account being counted toward that principle saving, with commonly only around 40% of what’s contained in that account working for you toward paying off your mortgage.
The Advantages Of An Offset Account
Now the good news!
Offset accounts can be great for people who like to separate their money. Recently a certain, let’s call him, “financially savvy man without shoes” very successfully promoted the idea of separating all of our money into different accounts to fully understand our cash flow and promote healthy savings habits.
This method is tried and true by many Australians and has helped people change the way they view and save their money. If this is what you are used to and it works for you then, by all means, apply this to the structure of your home loan by using multiple offset accounts.
It is definitely worth noting that an offset account is always a better place to store your money once you have a mortgage, than a regular savings account. If your mortgage is 6.5% and the savings account only 5% you can see that you should always go with where your money earns you more.
Also you have to pay tax on interest accrued in a savings account but you don’t pay that same tax by keeping your savings in an offset account.
It’s just like any other source of income, you need to declare any interest you’ve earned on an Australian savings account when you do your tax return. So now you can see now that keeping money in an offset account is much like keeping money in your superannuation, they can’t touch it and considering they say death and taxes are the only inevitable things in lifeit’s nice to find a tiny loophole out of at least one of them.
Another benefit of having money in your offset is if you ever choose to rent out your property for whatever reason, you can empty your offset account attached to the property and gain a maximum tax deductible debt against what is now an investment property. Just a little thought for later should your world incur a sudden change.
Sally Tindal, research director for Rate City, says:
“While offset accounts work well for many borrowers, there is little point paying more to have the feature if you are not making use of it. Fees can easily negate savings from having money in the account. In some cases, you could end up paying more.”
So at the end of the day the type of saver or spender you are should be taken into account when deciding if a home loan package that contains offset accounts works for you. Lots of cash flow? Use an offset account. Scraping by each month? Save on the fees and simplify with a basic loan.
Is It Better To Pay Off My Loan Or Leave It In An Offset Account?
Schools of thought around this topic have varied hugely over the last ten years, again this being linked to a time of much lower interest rates. We have just stepped out of an era where leaving a fat offset might have been beneficial, with some fixed interest rates dipping down to 2.15% (don’t cry) during the pandemic.
It’s also interesting to note that when Australian banks, in cahoots with the government, seemed to give home owners a “get out of jail free” card by halting their loan repayments during the most uncertain part of the COVID-19 crisis, they did not stop the interest they were accumulating on the principle amount with the paused repayments, thereby extending the term of the embattled Australian’s loan by around fifteen months. Nice one banks.
Understandably if you clear your loan and pay off your house quickly, you have exhausted your disposable cash, thereby emptying your offset account where it was held. The thing is though: you now own a house so any additional money you require from the bank or alternative lender can be taken out as a personal/ holiday/car loan using this impressive asset as equity, and you can shop around for a rate that suits you.
Reevaluating your options, after paying off a significant amount of your loan, whether through your offset account or not, is the best way forward as the interest is the killer. If you really want to terrify yourself, simply look up the interest paid on a $400,000 loan over the span of thirty years, then terrify yourself some more by wondering how anyone found a place to live in a city for under $500,000? You’ll have to sleep with the light on for the next week.
It is hugely important to realise and remember that any interest saved from your offset account is calculated monthly, whereby the interest on your loan is calculated daily. Every year you lessen a 30 year loan by, the more you will save yourself.
Why The Banks Want You To Have Offset Accounts
Basically, banks want you to feel like offset accounts are the only way forward, and they will confuse you as much as possible when explaining to you why you require a loan with offset accounts — because, to them, getting that yearly fee plus the gigantic amount of money they make from the interest on your loan is just money for jam.
I liken it to when the police go on a ticket blitz. We are led to believe it’s for our own safety (though road accidents and deaths may not have statistically shown any increase), when really you just know they have been told by a “higher up” that they need to increase revenue flow. To be fair, the cops might actually need it — the banks certainly don’t.
Almost every bank offers free instant redraw on any excess funds, something that they don’t advertise, allowing you to keep excess funds in your mortgage without paying ‘wealth package’ fees for an offset account.
With this knowledge, could you just cut the idea of offset accounts and keep all of your spare cash, savings, and have your wages paid into your actual mortgage account? Technically yes, but the issue with this is that it doesn’t work for paying that string of direct debits we have every month and you need to be on a variable rate, but any excess sitting in your actual mortgage account contributes to the overall length of the loan and lowers your monthly repayments… just saying.
What are some of the alternatives to keeping money in offset accounts?
As I have just mentioned, keeping money in your primary mortgage account is great but you might want to broaden your horizons or hedge your bets.
Seeing a financial advisor can help manage your money and they may suggest effective alternatives for the savings, such as paying down capital, diversifying into other assets such as equities, or using the lump sum as a deposit for an investment property. It is important to remember that all types of investments come with risk and the best way to avert risk is to educate yourself.
Good luck!
