What is an offset account and how can it save you money?

Reducing the amount of interest on your home loan takes more than just a competitive rate. The features you choose also play an essential role.

One of the more popular features is an offset account - but what exactly is it and how can it help bring down the interest you pay on your mortgage? Below, we explain the ins and outs of an offset account so you can decide if it’s right for you.

An offset account is just like an everyday bank account, except it is linked to your home loan. You can have your salary deposited into the account and set up direct debits for any bills. 

When you open an offset account you will receive a debit card from your home loan lender, which you can use to make everyday purchases.

The major benefit of using an offset account is the balance will be offset daily against the home loan principal, bringing down the amount of interest you pay. For instance, if homeowner Lisa has a $500,000 home loan and $50,000 in an 100% offset account she will only be charged interest on $450,000.

Big bucks! An offset account with a sizable balance will not only reduce the amount of interest you pay but the length of the term as well.

Let’s use the same home loan scenario as above. Over a 30 year term with a 5% interest rate, if Lisa maintains a balance of $50,000 in her offset account over the life of the loan she can save around $142,000 in interest and pay off her loan four years and four months earlier.

While many variable rate loans come with an offset account, they are not so common among fixed rate options. Among the few fixed rate loans that do offer an offset account, many are only partial or require you to pay a fee.

However, some split loans, which divide your loan into fixed and variable rate accounts, allow you to have an offset account on the variable portion.

For instance, say Lisa decides to fix $200,000 of her home loan and leave $300,000 variable. Because she has $50,000 in an offset account she will only be charged interest on $250,000 of the variable portion.

Another feature that will bring down the amount of interest you pay on your home loan is an extra repayments facility, which allows you to deposit extra money into your home loan. But which feature is better for you? Here are the pros and cons of each:

Offset account

Pros:

• Brings down the interest you pay and reduces the life of your loan

• Redraw on the amount in the offset account without incurring a fee

Cons:

• Not actually reducing the principal of the loan

• May be charged a higher fee for having the offset facility included in your home loan package

Extra repayment facility

Pros:

• Brings down the interest you pay and reduces the life of your loan

• Often available with fixed rate loans, though there may be annual caps

• Reduces the principal of the loan

Cons:

May be charged a fee for dipping into extra repayments you’ve made

Less flexible, as you may have a cap on how much you can redraw

Offset accounts and extra repayment facilities are both great options for bringing down the principal of your loan, while allowing you to draw on that amount later on if needed. But there are plenty of other features out there that provide great flexibility. 

For an overview of repayment holidays, home loan top ups and more, read our in depth guide on home loan features.

That depends on the bank or lender. Some home loans that come with an offset account facility charge a monthly service fee. You could also be charged a steeper interest rate, especially if you’re signing up with a full feature home loan that comes with a range of other features like fee free extra repayments, a redraw facility and home loan portability.

It’s tax free, as the savings you make through reducing the amount of interest you pay on your loan are not classified as income.

Keep in mind when you’re comparing home loans that there is a difference between a partial offset account and a 100% offset account.

Partial offset

There are two different types of partial offset accounts available:

• Portion of your balance. Your provider may offset a percentage of the balance in your offset account to reduce the principal of your loan and the interest you pay. For example, if Lisa signs up with a loan with a 40% partial offset facility, $20,000 of her $50,000 balance will go towards bringing down the principal. So on a $500,000 home loan, she would only pay interest on $480,000.

• Discounted rate. Another type of partial offset you may be offered is a discounted interest rate on the balance in your offset account. For instance, a home loan with a 5% interest rate that offers a 1.5% discount will mean you will only be charged 3.5% on the balance in the offset account.

100% offset

As the name suggests 100% of the balance in your account will be offset against your home loan. So in the above scenario, the full $50,000 will be offset against Lisa’s $500,000 home loan amount and she will only pay interest on $450,000.

Replace your bank account with your offset account. There’s no point signing up with a home loan that charges a higher interest rate and monthly fee if you’re not going to use the feature. So consider replacing your everyday bank or savings accounts with your new offset account.

Get your salary deposited into the account. The best way to reduce the interest on your home loan is to have as much money in the offset account as possible, as your balance will be offset daily. So your first call of action when you set up your offset account should be to contact your employer/s to give them the account details.