The power of offset accounts
What is an offset account?
An offset account is simply a savings account linked to your mortgage balance. Whatever funds are present in the account are netted off or ‘offset’ against what you owe. For example, where you have a $500,000 loan but $50,000 in the linked offset account, you will only pay interest on the $450,000 (being $500,000 less $50,000).
What are the benefits of an offset account?
- The biggest draw of an offset account is free overpayments. Any extra dollar which you can save reduces your mortgage interest (which in turn reduces the loan amount faster). This would include your emergency funds and savings for holidays or renovations or anything else.
You could even park your salary into your offset account and live off a credit card until the bill is due (which you should then pay in full) to reduce daily interest to truly maximise money efficiency.
- The benefit obtained from parking cash in an offset account would be at rates of 3.50% to 4.00% (i.e. the benefit from reduction of the principal amount which you are paying interest on) should always be higher than the interest generated on a standard bank account (being approximately 1.5% to 2%).
- The benefit obtained from parking your cash in an offset account is not an actual cash payment (rather, you are just avoiding a higher interest payment) and is therefore not taxed.
- Leaving your surplus funds in the offset account would be as convenient as leaving your funds in an everyday transactions account – you can access your money from ATMs. A traditional loan account does not have ATM accessibility.
- Lower minimum repayments and greater flexibility in use of your funds. Rather than having your funds locked down in a traditional loan account
Here is an example
Imagine a scenario where you earn a salary of $90,000 per year and you are in the 37% tax bracket. You are still living at home and have a $500,000 loan for your investment property at a 3.5% interest rate. You have $50,000 of funds in cash.
Where you have an offset account and your cash is parked in your offset account, you would be paying yearly interest of $15,750 (3.5% of $450,000).
Where you hold a traditional loan account (with $500,000 owing) and a high interest savings account (with $50,000 accruing at 2%), the following would occur:
- Pay interest of $17,500 (3.5% interest on $500,000);
- Receive interest of $1,000 (2% interest on $50,000); and
- Pay tax on the interest from the savings account of $370 (37% of $1,000).
The net position would be a net payment of $16,870 each year. That is a cash difference of $1,120 each year.
Is an offset account suitable for me over a traditional loan account?
Most fixed rates offered in the market do not come with 100% offset facility. As such, certain customers such as young families or couples on tighter budgets who wish for certainty in their loan repayments would be better off with a fixed rate under a traditional loan account.
Offset accounts provide the most benefits to customers who:
- wish to minimise repayment commitments for overall cash flow purposes;
- anticipate large expenditure items in the near future (such as a wedding or another property purchase);
- have a significant cash balance which would be most efficiently used to offset a loan balance.
Everyone has a unique set of personal financial circumstances and priorities. With access to a wide variety of lenders, I am always happy to discuss which loan package is most suitable for you either in person, over the phone (02 8378 4293) or via email (email@example.com)