Your home is probably the biggest purchase you’ll ever make and your home loan is probably the biggest contract you’ll ever find yourself locked into. Over the life of your loan you’ll pay an enormous sum in interest too. But if your home loan has an offset account you can shorten your loan term and reduce the amount of interest you have to pay, and you won’t need to spend a cent.
How do offset accounts work?
An offset account is a deposit account attached to your home loan. You can put money into it like a bank account, but the money in the offset account reduces the amount of interest you owe, helping you to pay off your loan faster.
Here’s how it works. Say you borrow $600,000 to buy a home. This is the loan principal. You have to repay this amount, plus interest. If your loan term is 30 years and your interest rate is 3.80% then your monthly repayments would be $2,795.74. Over the 30-year life of your loan you’ll end up paying $1,006,467.88, which equals over $400,000 in interest.
But what if you put $20,000 of your savings into an offset account? The amount in your account literally offsets the total amount that your interest is calculated on. Now your interest repayments will be calculated based on a $580,000 principal, instead of a $600,000 one.
Your monthly or weekly repayments won’t change, but you’ll be paying less interest and more off your principal. Assuming you don’t spend that $20,000 (and we’ve calculated from the start of the loan term), putting that money in your offset account will save you $40,409 and reduce your loan term by just over one year.
Not a bad return on $20,000.
Why can’t I just use my extra funds to pay off my home loan faster?
True, you could skip the offset account and just pay off more of your principal. But what happens if you suddenly need cash to spend? You can withdraw funds from your offset account and spend them in emergencies just as you would with a savings account. This is another big advantage of an offset account.
While many home loans offer redraw facilities that let you withdraw any extra money that you’ve paid towards your loan, they often charge fees for doing so.
You can also use your offset account to save on your tax bill.
Can I earn interest on the money in an offset account?
No. Unlike a normal savings account you won’t earn interest on the money in your offset account. But the interest rate on your home loan is bound to be higher than the rate on your savings account. The money you save on interest repayments with an offset account will most likely put you ahead overall.
Offset accounts sound great! Is there anything I need to watch out for?
Offset accounts are great but not every home loan offers one. Offset accounts are more commonly found with variable rate home loans and with full-featured loans that may charge higher interest rates.
But the home loan market is so competitive now that you can often find basic or low-rate home loans and even fixed rate home loans with offset accounts attached.
Some loans provide an offset account but charge a monthly fee for it, so that’s something to watch out for. You also need to look out for partial offset accounts. Unlike 100% offset accounts, a partial offset account will only reduce your interest repayments by a portion of the amount saved in the account rather than the whole amount.