What is an offset account and how can it help you own your home sooner?
One of the easiest ways to repay your home loan faster is to use an offset account. Here’s a guide to how offset accounts and redraw facilities can help you own your home sooner.
An offset account is where you can keep funds in excess of your mortgage and, while those funds are there, the positive balance is counted against the principal of your home loan when the lender calculates the interest. This reduces the interest you pay, which means your repayments eat into your principal to reduce your loan at a faster rate.
For example, if you have a loan balance of $100,000 and you have a positive balance of $10,000 in an offset account, your home loan balance is reduced to $90,000 for the purpose of calculating interest on the loan. The $10,000 offsets the outstanding balance on your loan.
The other key benefit of an offset account is that it has all the flexibility of a transactional account, so you can use the positive balance as required for your everyday living expenses.
Here are three ways to use an offset account.
1. Park your savings in the offset account
Say you have a term deposit somewhere, or a few thousand dollars lying around in another account earning a bit of interest. If instead you put these savings into an offset account, the interest that you offset on your mortgage is likely to be greater than the interest you would earn in a term deposit or cash account.
Also consider that the interest you earn may be considered part of your taxable income, whereas mortgage repayments are not, which could affect your personal income tax calculations.
2. Deposit your salary into the offset account
Have your employer deposit your salary into the offset account and use it as your primary transaction account. Since home loan interest is calculated daily, any funds you keep in your offset account will reduce the balance of your mortgage. You can still withdraw the funds, as you need them for your regular day-to-day expenses.
3. Use a credit card in tandem with your offset account
The more money you keep in your offset account and the longer you keep it there, the more it will reduce your home loan interest. In addition to keeping all your excess money in the offset account, many people like to use a credit card to ‘defer’ expenses.
Say your salary of $5000 a month goes into your offset account. If you use a credit card for expenses, you can keep that $5000 in the account until your credit card bill falls due. You need to be disciplined to benefit from this however. You cannot spend more than your income on the credit card and you must make a full credit card repayment when it falls due to avoid paying interest on the card, which is a lot higher than the interest on your mortgage.
What is redraw?
Another popular way to speed up your home loan repayments is to have a redraw facility attached to your mortgage. The concept is similar to an offset account – any excess funds contributed to the loan in a redraw facility reduce your loan principal, which in turn reduces the interest you pay. The key difference is that the positive balance is more difficult to access and there may be associated costs.
Some customers prefer to use a redraw facility because they are less tempted to spend the excess funds than they would be with an offset account. It’s possible to keep savings there until you require a lump sum, to fund a holiday for example, when you can redraw all or part of the excess. In the meantime, the positive balance works to reduce your loan. Some redraw facilities attract a fee upon withdrawing excess funds.
What is an offset account?
Who benefits from offset and redraw?
Offset and redraw facilities are ideal for people with a variable rate residential mortgage who wish to repay their mortgage as quickly as possible. An offset or redraw account most benefits those who are disciplined enough not to spend more than the excess funds they contribute.
Those with a fixed rate mortgage will rarely have access to offset or redraw facilities as the lender sets repayments for the duration of the loan term. It is possible, however, to fix a portion of your home loan and subject the rest to a variable rate with offset or redraw facilities so you can benefit from both types.
Offset and redraw facilities have the least benefit for investors because a mortgage on an investment property attracts tax benefits from the loan interest.
If you’re interested in an easy way to reduce your mortgage and pay it off faster, offset and redraw are two of the most common facilities for home owners. Talk to your adviser to see if these could work to help reduce your repayments.