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.
Ready? 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 or lender is charging you on the remaining amount of 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’s 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 prevent you from looking like a possum in the headlights when faced with the myriad of choices they will (unwittingly) 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 both 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 its cover.” It’s the same with your home loan and you need to establish early what you are signing up for.
And it’s not only an annual fee that may cause issues: 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 going 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 homebuyers in Australia 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, once you have a mortgage, an offset account is always a better place to store your money 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.
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 — the taxman can’t touch it and considering they say death and taxes are the only inevitable things in life, it’s nice to find a tiny loophole for 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 not have been as beneficial, with some fixed interest rates dipping down to 2.15% (please don’t cry) during the pandemic.
Understandably, if you clear your loan and pay off your home quickly, you have exhausted your disposable cash, thereby emptying your offset account where it was held. The thing is though: you now own a home 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.
It is important to realise that any savings on the interest from your mortgage (by the money kept in your offset account) is calculated daily and applied at the end of the month.
While this might not seem like an earth-shattering amount, it certainly adds up over time. Any fluctuations in the money contained in your offset account directly affects the interest you pay at the end of the month. Up in offset, down in interest — and vice versa.
This means that any lump sum you receive can happily live in your offset account to help out and even if it doesn’t ultimately get to live there permanently, every little saving counts.
Reevaluating your options regularly over the life of your loan (after paying off a significant amount of your loan, whether through your offset account or not) is the best way forward.
What Alternatives Are There To Offset Accounts?
While not every lender offers offset accounts, almost every bank or lender offers redraw on any excess funds kept in your mortgage account, something that they don’t necessarily shout from the rooftops but is great to know. Does your bank or lender offer unlimited redraw from your primary mortgage account? Even better, as keeping any ‘surplus’ funds in your main mortgage account works the same as using an offset account, but without paying ‘wealth package’ fees for the said offset account(s).
With this knowledge, you might be asking if you could just cut the idea of offset accounts and keep all of your spare cash and savings, plus have your wages paid into your actual mortgage account? Technically, yes absolutely, but mortgage accounts do have caveats, like that string of direct debits we have every month that cannot be drawn from this type of primary mortgage account. Also, unlike offset accounts, you cannot have a card linked to your mortgage account. Redraw or not, it is harder to spend your money on a whim when it is sitting in your mortgage, which many might even say is a good thing.
The biggest advantage is probably psychological. Seeing a reduced amount owing directly in your mortgage account? It just feels good.
So there you have it! Keeping money in your primary mortgage account is great, but offset accounts can also be great. ‘Different strokes for different folks’ is a proverb that definitely applies to banking and the way you structure your mortgage. Who knows, you might want to broaden your horizons or hedge your bets. If so, then seeing a financial advisor can help you manage your money and help you further understand what is best for you. They may suggest effective alternatives for your savings. It’s important to remember that all types of investments come with risk — and the best way to avert risk is to educate yourself.
Good luck!