An offset account can be a powerful tool to cut years off your home loan and reduce the interest you pay – if you know how to use it strategically. For Australian homeowners, understanding the ins and outs of an offset account could be the key to achieving financial freedom sooner.
What is an Offset Account?
An offset account is a transaction account linked to your home loan. The balance in this account reduces the amount of interest charged on your loan. For instance, if you have a $500,000 loan and $50,000 in your offset account, you’ll only pay interest on $450,000.
Because interest on home loans is calculated daily and charged monthly, every dollar in your offset account counts towards reducing your interest payments.
How Does It Work?
The main advantage of an offset account is that it reduces the principal loan amount on which interest is calculated. This can result in significant savings over the life of your mortgage.
Let’s take a look at two realistic scenarios to understand how much you could save.
Scenario 1: $40,000 Offset Balance
Based on a 5.5% interest rate with monthly repayments, the interest savings from a $40,000 offset account on a $400,000 loan would be approximately $41,760, and the loan term would be reduced by about 6.3 years.
Scenario 2: $40,000 Offset Balance + $100 Weekly Contributions
By adding $100 weekly contributions to that same offset account, you could save approximately $204,630 in interest and reduce your loan term by 9.75 years, cutting a 30-year loan down to just over 20 years.
These savings demonstrate how even small, regular contributions to your offset account can significantly reduce both the interest you pay and the time it takes to pay off your mortgage.
Simple Strategies to Maximise Your Offset Account
Maximising the benefits of your offset account doesn’t require drastic changes to your lifestyle. Here are some practical strategies you can implement:
- Leave Savings and Income in Your Offset Account as Long as Possible Since interest is calculated daily, the longer your money sits in the offset account, the more interest you save. Aim to keep as much of your savings in the account for as long as possible.
- Use Your Salary to Your Advantage Consider having your salary paid directly into your offset account. This keeps your account balance higher for longer, reducing your daily interest charges.
- Time Your Expenses Wisely Timing your expenses to align with your income cycle can help maximise your offset balance. For example, schedule direct debits for the day before your next pay cycle to keep the account balance higher for longer.
- Consider Using a Credit Card for Everyday Expenses Some borrowers use credit cards for everyday purchases and pay off the full balance each month from their offset account. This strategy can keep your offset balance high throughout the month, but it requires discipline to avoid accruing credit card debt.
The Bucket Budgeting Approach
If your lender allows for multiple offset accounts, you might benefit from a “bucket budgeting” approach. This method involves setting up separate offset accounts for different expenses such as household bills, groceries, and entertainment.
By allocating funds into specific buckets, you can manage your expenses more effectively while still reducing the interest on your home loan. This method gained popularity through financial guides like The Barefoot Investor and can be a useful way to stay within your budget.
Offset Accounts vs. Redraw Facilities
If your home loan doesn’t offer an offset account, a redraw facility is another way to reduce interest. With a redraw facility, you make extra repayments directly into your home loan, reducing the principal and, therefore, the interest charged.
However, there’s a key difference to keep in mind if you’re planning to turn your home into an investment property in the future. Funds in a redraw facility reduce your loan balance, which can impact the tax deductibility of the loan when the property becomes an investment.
Using an offset account instead can help preserve the loan’s tax-deductible status. This could save you thousands at tax time if you later purchase a new owner-occupied property and convert your current home into an investment.
Is an Offset Account Right for You?
While an offset account offers significant benefits, it’s important to weigh the costs. Some home loans with offset accounts come with higher fees or interest rates, so you’ll need to determine whether the savings outweigh these costs.
Consider your financial goals and lifestyle when deciding if an offset account is the right fit. If you’re able to maintain a healthy account balance, the savings can be substantial.
Final Thoughts
An offset account can be a game-changer for reducing your mortgage faster and saving thousands in interest. By understanding how it works and adopting smart strategies, you can make your home loan work harder for you.
If you’re unsure whether an offset account is the right option for your situation, a mortgage broker can help guide you through your options and ensure you’re making the best decision for your financial future. After all, every dollar saved today is a step closer to financial freedom.
