Article by Mozo
Reducing the amount of interest on your home loan takes more than just a competitive rate, as the features you choose also play an essential role.
One of the more popular features when it comes to bringing down the interest you pay is an offset account - but what exactly is a mortgage offset?
In this guide we’ll explain the ins and outs of an offset account, so you can decide whether 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 get your salary deposited into the account and set up direct debits for any bills. When you open your 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 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 considerable 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 maintained a balance of $50,000 in her offset account over the life of the loan she will save around $142,000 in interest and pay off her loan 4 years and 4 months earlier.
Generally only variable rate loans come with the option of a 100% offset account. However, some split loans, which fix a portion of your loan and leave the remainder variable allow you to have an offset account that will reduce the amount on the variable portion.
For instance, say Lisa decides to fix $200,000 of her home loan and leave $300,000 variable, on the variable portion because she has $50,000 in an offset account she will only be charged interest on $250,000.
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:
Extra repayment facility
Offset account and extra repayment facilities are both great options for bringing down the principal of your loan, whilst allowing you to draw on that amount later on. But there are plenty of other features out there that provide great flexibility. From repayment holidays to home loan top ups, read our in depth guide on the features available in the home loan world.
Yes many home loans that come with an offset account facility charge a higher monthly service fee, compared to no frills home loans that may come with no monthly fee at all. 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 flexible 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.
There are two different types of partial offset accounts available:
As the name suggests 100% of the balance in your account will be offset against your home loan. So as mentioned above with Lisa’s scenario the full $50,000 will be offset against her $500,000 home loan amount and she will only pay interest on $450,000.
1. 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 make sure you replace your everyday bank / savings accounts with your new offset account, so that you’re getting the most value from the facility.
2. 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 details of your account.
3. Pay for everyday purchases with a credit card. Consider paying for all your expenses via a credit card to ensure you have the highest possible amount in your offset account at all times. Of course this tactic is only if you know you won’t be tempted to spend out of your means and can pay your credit card balance in full each month.Home loan features guides