What is an offset account and do I need an offset account?

An offset account is a savings or transaction account linked to your home loan account. The balance in the offset account is "offset" against the balance in your home loan account. This means you're only charged interest on the difference between your home loan balance and the balance in your offset account. For example, if you have a home loan balance of $300,000 and $50,000 in your offset account, you'll only be charged interest on $250,000. Benefits of an Offset Account: Interest Savings: The main benefit is the potential savings on interest payments. Because you're charged interest on a lower amount, you may pay less interest over the life of your loan. Flexibility: Money in your offset account can usually be accessed easily, providing flexibility for your day-to-day finances. Reduce Loan Term: The savings on interest can be used to reduce the term of your loan, helping you to pay off your home loan faster. Tax Efficiency: For investment properties, an offset account can be a tax-efficient way to save money. Unlike earning interest on savings, which is taxable, the savings achieved through an offset account are not considered taxable income. Do You Need an Offset Account? Whether you need an offset account depends on your financial situation and goals. Consider an offset account if: You Have Excess Cash: If you regularly have a significant amount of cash that could be offsetting your mortgage, it might be beneficial. You Want to Save on Interest: If you're looking to save money on interest without locking your funds away, an offset account can be effective. You Seek Flexibility: If you want the flexibility to access your savings quickly while still saving on interest, an offset account offers both. You Have an Investment Property: For investment property loans, the tax efficiency of an offset account can be particularly beneficial. Points to Consider: Fees: Offset accounts can come with higher monthly fees or require a higher interest rate on your home loan. It's important to calculate whether the interest savings will outweigh any potential costs. Interest Rates: Compare the interest rates of home loans with and without offset accounts. Ensure the benefits outweigh any possible higher interest rates or fees. Financial Discipline: Since funds in an offset account are usually easily accessible, you need financial discipline to avoid spending your savings and reducing the benefits. In summary, an offset account can be a powerful tool in managing your mortgage and saving on interest payments, but it's essential to assess your personal financial situation and goals to determine if it's the right choice for you.

Offset accounts are popular in Australia, and I was surprised that people from the US had never heard of the offset account when coming to Australia. In fact, an offset account does not exist in the US due to tax law, where the IRS does not allow taxable interest paid and interest received to cancel each other out, and each must be reported separately. That pretty much sums up the concept of an offset account - interest paid (to home loan account) and interest received (from an offset account) to cancel each other out. Bank calculates the daily loan balance minus the account balance from your offset account to work out the daily interest. At the end of the month (or end of the statement cycle), it sums up all daily interest to work out the total interest for that month. It is popular because it helps to reduce the interest you pay over the life of your loan. In other words, you are getting paid an interest rate on your offset account that is equal to the interest rate of your home loan. That is significantly higher than any interest savings account or 1 month term deposit you can find. What’s more, an offset account is just like any transaction account, you have the flexibility with your money, and you can access anytime, set up direct debits, or pay for shopping on an ATM card. However, there is a cost for this convenience of having an offset account. Lenders package the offset account with a premium product, so you have to sign up for the higher interest standard variable rate home loan and pay an annual package fee to offer this luxury. The interest rate on the standard variable rate home loan can be as high as 1.00% higher than the basic variable rate home loan with a $395 annual package fee. While you are saving interest from the balance available in your offset account. You are paying roughly $450 more a month for having the offset account. Is it really worth the money? The short answer to that is “No”, you don’t need an offset account and achieve a similar result, ONLY IF you are organised and disciplined with your money. Noticed that I used capital letters, because it might not suit everyone and it can get really messy if not done right. While both basic variable rate home loan and standard variable rate home loan have the same basic features such as variable interest rates, unlimited redraws, and most lenders don’t charge a redraw fee. Basic variable rate is a no frill home loan, it does not have the linked offset account, but it offers a much lower interest rate. The redraw facility is a powerful tool if it’s used correctly. Customers can make extra repayments into the home loan to reduce the loan amount anytime to reduce interest. The Redraw facility basically allows customers to transfer those extra repayments out of the home loan anytime. Some lenders have conditions to the minimum redraw amount, and some charge a redraw fee. While most lenders offer unlimited redraw, with no minimum redraw amount and no redraw fee, please make sure you fully understand the home loan product that you are signing up to avoid future surprises. If you are disciplined, you can transfer your income into the home loan, and redraw the required amount to pay for living expenses. You also need to be very organised to diarise all bills and direct debit amounts and dates to make sure your everyday account has sufficient funds available to avoid overdrawn. You can also consolidate your grocery shopping on the credit card, and make FULL payment at the end of the statement cycle. If you have an investment property loan, an offset account can be useful to manage cash flow. You can use the same concept by fully utilising the redraw facility and a normal everyday account to manage cash flow. However, make sure you don’t redraw money from your investment property loan for and spend it on a holiday or any other personal expense, as there could be some major tax implications you may run into. You might not qualify to claim tax deduction on the portion used for personal purpose, and you don’t want to get into trouble with the ATO. So speak to a good accountant and ensure you know what you can and can’t do with your investment loan.