Compare home loans with offset accounts

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What is an offset account and how does it work?

An offset account is essentially a transaction account linked to your home loan where the account's balance 'offsets' the outstanding home loan debt so you'll only be charged interest on the difference.

For example, if you have a loan of $610,000 and have $60,000 in a linked offset account, you would only have to pay interest on the difference - $550,000.

But it doesn't mean your regular loan repayments drop. They remain the same, so by having money in an offset account, you're effectively saving on interest and paying off your loan faster.

To see just how much you could potentially save on interest costs with an offset account, check out Savings.com.au's Mortgage Offset Repayment Calculator.

Do you earn interest on money in an offset account?

No, you don't earn any interest on funds in an offset account, but the money you keep there helps you save interest on your home loan.

Many people with mortgages choose to keep the bulk of their spare cash in offset accounts for this reason.

As home loan interest rates are typically higher than the interest you can earn by keeping your money in a savings account, you will generally come out ahead by storing your cash in an offset account. And that's before accounting for the fact that savings account interest earnings are taxable.

What home loans come with an offset?

Offset accounts are typically linked to variable-rate home loans. Very few lenders offer an offset account with a fixed-rate loan which generally come with lower interest rates but less flexibility in making extra payments.

See also: How to choose between a fixed-rate or variable-rate home loan

But not all variable-rate loans come with an offset account. Basic home loans are typically low-interest, low-fee variable-rate loans that don't typically offer an offset option.

Generally, borrowers will pay a slightly higher rate of interest on a variable-rate loan that comes with an offset account. That's because lenders know those borrowers have the capacity to make considerable savings in interest and possibly pay off their loan much sooner.

Other lenders will only offer an offset account as part of a package home loan where borrowers pay an annual fee that allows them to combine a number of banking products.

As with all home loans, it pays to thoroughly research the market and individual loan products before you dive in.

What's the difference between 100% offset, partial offset, and capped?

Not all offset accounts are the same. Here are a few variations you may come across in the market:

• Full offset account: Generally, lenders will offer '100% offset' which means the entire sum in the offset account can be subtracted from the loan amount.

• Partial offset account: Some lenders may offer only partial offset, such as 50% or 80% of the account balance offsetting the loan amount. These are more common with some fixed-rate home loans.

• Capped offset account: Other lenders may cap the amount you can have in your offset account.

• Multiple offset accounts. Some lenders allow borrowers to link multiple offset accounts to a home loan, with the balance of each account adding up to reduce the interest payable on the loan. Multiple offset accounts are designed to give borrowers greater flexibility in how they allocate and store their cash without losing any offset benefit.

Jenny Inhof

Just Create It Digital founder & Sydney-based rentvestor

"Normally I'd invest my extra cash … but because interest rates are so high at the moment, I am focusing on building a nice lump sum in my offset account to reduce my mortgage over time."

Maximising your offset account

To save yourself the most in interest using an offset account:

• Ensure it is a 100% offset account. These are the most common on the market but make sure you're reaping the full benefit of the cash you're storing in your offset account.

• Stash money in your offset account as early as possible. The sooner you get cash into the offset account on a new loan, the sooner you'll start saving in interest. Even a small amount can make a major difference over the long term.

• Keep maximum money in the offset account. If it's possible, have your income paid directly into your offset account to give it the maximum boost you can before you need to access the funds.

• Add money as you can. Top up your offset as often as you can with tax returns, bonuses, windfalls, etc.

• Limit or delay withdrawals. Although it's as easy to withdraw cash from your offset account as from any transaction account, doing this means you'll have less money working to lower the interest charged on your home loan. Leave paying your bills until the day they are due, or check the suggested strategy below.

Credit card method of offset maximisation

One method that some borrowers use to keep the most in their offset accounts is to put all their income into their offset and use a credit card for their purchases and expenses throughout the month.

Critically, they then make a monthly lump sum payment from their offset account to their credit card provider to bring the credit card balance back to $0. Doing this avoids any interest charges and fees from the credit card and also keeps the offset amount as high as possible for a longer period.

Costs associated with offset accounts

As with many features that go with financial products, there are often fees, premiums, and trade-offs involved.

Some of the common fees and premiums associated with offset accounts can include:

• Higher interest rates

• Transaction fees

• Application/establishment fees

• Monthly account keeping fees

While saving money long term is the focus here, it's worth doing the maths to ensure the fees or higher interest rate you'd be required to pay don't end up costing you more than the amount you'd save in interest by having an offset account.

Case study

Let's consider an example. Hoff Sette borrows $450,000 at a variable-rate of 5.00% p.a. paired with a 100% offset account. The loan bears no additional fees but has an interest rate premium of 0.10% compared to a loan without an offset account (4.90% p.a.). Hoff immediately deposits $25,000 into the offset account and keeps it there for the entire 30 years of the loan.

If we assume, for simplicity's sake, that the interest rate stays at 5.00% p.a., the savings Hoff makes from the offset would be around $77,000 - much more than he would save by opting for the 4.90% p.a. mortgage rate. The offset account also helps him pay off the loan much sooner, so it's a win-win for Hoff.

Should I make extra loan repayments or put the cash into an offset?

This is a common dilemma many mortgage-holders face. In theory, having an offset account is very similar to making extra repayments on your mortgage and using the loan's redraw facility to withdraw funds if you ever need them.

Both options save you interest and help you pay off your loan faster, but still give you access to your money.

The major difference is that the money in an offset account is your money while the extra payments you make on a loan belong to the lender. That's why some lenders can put restrictions or fees on redraws, or have the right to change their redraw rules after you've taken out the loan.

Offset accounts give you more flexibility and control of your own cash while redraw facilities may put a barrier or two in place. (However, some borrowers who can be a little too liberal with their own readily accessible cash may prefer this.)

See also: Redraw vs Offset: Pros and Cons

What happens when my offset balance is the same as the loan balance?

This is a great position to be in - congratulations. But it means you'll have a decision to make.

In practical terms, you have the choice of moving your offset savings into the loan and discharging your mortgage. But if your offset also serves as your proxy savings account, you will find yourself without any back-up cash which you might need in an emergency.

You'll need to consider how much to put into the loan and how much to keep accessible in your offset account.

If you decide to continue to keep offsetting your loan, it essentially means that your ongoing mortgage repayments will be paying down the loan's principal and you won't be paying any interest. That's also not a bad position to be in.

See also: Should I put money in my offset or pay off my mortgage early?