Using a Mortgage Offset account is one of my favourite strategies for paying off your mortgage faster. Many of you probably have one of these accounts as part of your home loan package. I have an offset account myself, although there are some pitfalls to using one, and it doesn’t always work well for everyone.
What is an offset account?
An offset account is a bank transaction account that is linked to your mortgage. Any positive balance in this account is offset daily against the money you owe on your home loan. This reduces the amount of interest you pay on your home loan. For example, if your loan is $500,000 and you have $100,000 in savings in an offset account, you will only pay interest on the outstanding home loan balance of $400,000. That is $500,000 loan minus the $100,000 savings. Keeping even a small balance in an offset account can cut years off the term of your home loan.
Tips For Using An Offset Account
So, the aim of the game when you use an offset account is to keep as much money as you can in the account to reduce the interest charged on your mortgage. Every day you leave an extra dollar in there makes a difference. But this is also where the main pitfall of an offset account comes it. It takes heaps of financial discipline! An offset account is just like a normal bank account which means you have access to the money in the account all day, every day, and every time you go to an ATM you can see the balance. So, if you can't handle the temptation to spend, an offset account is not for you! (Not to worry though, there are many other strategies you can use to speed up your mortgage repayments, which I have outlined in my post here).
To keep their offset account balance as high as possible many people, including myself, have all their income paid into their offset account. Wages, dividends, tax refunds, the lot. This means each dollar is offsetting your mortgage until it is spent on something. Many, take the strategy to a new level, by using their credit card to pay for all their expenses. Doing this means that your income hits the offset account and straight away reduces the interest bill on your mortgage, but your expenses are not paid until you pay your credit card bill at the end of the interest-free period. This maximises your offset account balance over the period. The key to using your credit card in this strategy is that you MUST pay off the balance EVERY SINGLE month. This can be easily organised through an automatic direct debit. If you cannot pay off your credit card every single month, do not even think of using this part of the strategy as paying 20% interest on your credit card does not make sense to offset a mortgage which is only charging 4% interest.
Other tips for using an offset account:
- Make sure it is a 100% offset account to make sure you are getting the full interest offset on any money you keep in the account. For example, if your interest rate on your home loan is 4% then the money in your offset account will offset the full 4% interest, if it is a 100% offset.
- Check how much the fees you are on your offset account are and make sure it is worth it. Estimate how much you think you will have on average in the offset account and how much interest that will save you. Just make sure that the interest savings are greater than the fees you are paying.
- Make sure you link the offset account to your home loan. A friend of mine had $100,000 in their offset account, only to find that they were being charged full interest on their mortgage because the two accounts were not linked!! Fortunately, she complained and got a refund of the excess interest charged.
- Using an offset account can be more tax effective than keeping your savings in a bank account. This is because if you have a savings account with 4% interest and say you are getting charged 37% tax on the interest earned, this is equivalent to roughly a 2.5% after-tax return. With the offset account you get the benefit of offsetting 4% interest without any tax as you are not earning any interest, as such. It is the equivalent of a 4% return tax-free.
Using an offset account can be a brilliant strategy to reduce your home loan, it just requires oodles of financial discipline. Without financial discipline, using an offset account can send your mortgage repayment strategy backwards fast. I can help you decide whether a mortgage offset or whether an alternative strategy would be better for you. Contact me here if you would like to know more, or to organise a coffee and a chat about your financial circumstances.
I hope you found this post helpful. If you did let me know in the comments.
Disclaimer: This information is of a general nature only and has been provided without taking account of your objectives, financial situation or needs. It does not represent and is not intended to be personal advice. Because of this, you should consider whether the information is appropriate in light of your particular objectives, financial situation and needs. We strongly suggest that you seek professional financial advice before acting.