Are offset accounts really a good idea?
Do you have an offset account on your mortgage? Are you thinking about applying for a mortgage with an offset account? Or do you not even know what a friggin’ offset account is?
Well, my friend, whatever the case, you are in the right place.
Welcome to mortgage offset accounts explained in simple terms.
A mortgage offset account is an ordinary bank account – just like an everyday account. However, there are some slight advantages.
You see, an ordinary everyday bank account earns little or no interest. So, if you have, say $5,000, in your everyday account, you will generally receive very little bank interest – something like 0.01% p.a.
Therefore, over the course of a year you would earn 50 cents on your $5,000. Whoaaa… hold on to your hats, don’t spend the 50 cents all at once!
Obviously if you’ve got $5,000, you’d be more inclined to have it sitting in an online saver or high-interest saver, rather than an everyday account. But even then, you’ll be getting max returns of around 2 – 3 % p.a. at the moment and you can’t make purchases from an online saver account, you need to first transfer what you need into your everyday account…. Such a hassle!
A mortgage offset account, on the other hand, combines the functionality of an everyday account with the higher rates of a saver account. In fact, the effective returns of an offset account are usually even higher than a savings account.
Let me define an offset mortgage account.
What is an offset mortgage account and how does it work?
Well, firstly, you need a mortgage.
An offset mortgage account looks and smells just like an everyday bank account. Your wage goes into it and your general expenses get paid out of it.
But there’s one key difference.
You see, every day your lender will look at your mortgage balance and charge interest on whatever the balance is every single day. And, the higher your mortgage balance is, the more in interest you will pay.
However, with an offset mortgage account, each day when your lender looks at your mortgage balance, they will first reduce the loan balance by the money sitting in your offset account and then they will calculate the interest payable, based on the prevailing rate.
This provides you with an effective, guaranteed after-tax return on your money equal to the rate on your home loan. So, if your home loan rate is, say, 5% and your highest personal marginal tax rate is 34.5%, then you are in fact earning a before-tax return of 7.63% simply by having money sitting in your offset account. Go on; read that again a bit slower this time, so it makes sense.
Should I get a mortgage offset account?
You’ll find that most major lenders will have a mortgage offset account as part of their home loan package. Some smaller lenders won’t offer a mortgage offset account, but will offer a lower interest rate, so you really need to weigh up whether you would prefer a lower interest rate, or the flexibility of an offset account.
Ultimately, if there’s an offset account on offer, it’s generally a good idea to have one.
Offset mortgage example
Okay, now just in case you’re thinking “is an offset mortgage account worth it?” here is an example, by the numbers, of the benefits of an offset mortgage, so you can determine for yourself if they’re any good.
,No Offset Account,Offset Account
Loan Amount,$450 000,$450 000
Interest Rate,5% p.a.,5%p.a.
Money in Bank Account,$7 000,$7 000
Daily Interest on Loan,$61.64,$60.68
Savings per month,,$29.16
Savings per year,,$350.00
So, are offset accounts a good idea?
It might not seem like a lot, but $30 each week could help towards your phone bill, groceries, insurances (or, more likely.. a family holiday 🙂 )
If you have more money in your bank account, then the savings are even greater. If you have less, the savings may be lower.
You might say, “well I don’t have $7,000 in my bank account”. And this is where interest free credit cards paint the rest of the picture.
You see, as part of your home loan package the banks will give you a credit card with, say, a $6,000 limit and an interest-free period of 30/45/60 days.
Therefore, if you have your wage paid into the offset account and use your credit card for purchases throughout the month – letting your wage build up each week, then you will find you will build up a balance in the offset account because you’re not spending your wage.
Just make sure you pay the credit card balance IN FULL before the due date, so as not to incur any interest. If you’re not very good with money, I would suggest staying away from the credit card altogether. This strategy does provide benefits, but sometimes it’s not worth the stress.
Read this article on Is It Good To Pay Off Credit Cards Right Away? Which talks about this in more detail.
Line of Credit vs Offset Account
So, what’s the difference between a line of credit and a mortgage offset account?
Well, we know what an offset account is – an account balance that reduces the mortgage value when the lender calculates the interest on your loan.
A line of credit is a loan amount without any fixed repayments. So basically, it is a fluid level of debt whereby you can make as much or as little repayments towards as you like – as often as you like – and interest is simply added to the loan value at the end of each month.
A line of credit will have a maximum borrowing amount and you are able to withdraw as much as you like up to this borrowing limit.
A line of credit is great for flexibility and removes the pressures of making monthly repayments, as it has no loan term.
The down side is that it you are not forced to make capital repayments towards the line of credit and is therefore not usually a good idea for people who are ill-disciplined with money, as you might never actually pay down your debt if you don’t have to! The other downside is that line of credits will generally have a higher interest rate compared to a standard variable principal and interest mortgage.
Lines of credit are much less common that ordinary home mortgage loans and you may not even be eligible. Your lender will determine your eligibility.
Offset Account vs Extra Repayments
A common question is whether it is better to make extra repayments to a loan, or to simply allocate any additional savings to an offset account.
The benefit of extra repayments is that you get in the habit of making more payments than necessary as part of your overall household budget, which is a good thing, and will result in you paying your mortgage off quicker. These days, most banks will allow you to redraw any additional repayments that you have made to your mortgage, so extra repayments do not necessarily mean that those additional payments are inaccessible in the future.
On the other hand, if you simply allocated any savings to an offset account, it has the same net effect as extra repayments; however because this money is sitting in an everyday bank account, it may be more tempting to access it when you know you really shouldn’t. It also doesn’t get you in that good habit of making extra repayments.
Extra repayments are probably the better option, provided you’re able to redraw the additional amounts if required, because it reduces the temptation to access the funds compared to the additional savings sitting in an offset account.
Offset Account for Investment Property
An offset account for an investment property loan works in exactly the same fashion as a home mortgage offset account. You will just need to organise with your lender for a particular account (or number of accounts) to be used to offset the investment property loan.
Hopefully now you know what a mortgage offset account means and whether having one is a good idea for you. But, if there’s still something you’re not sure on, hit me up with a question in the comments below and I’ll see if I can help.