How Does an Offset Account Work?

Owning your own home can be a rewarding and satisfying experience. But it often comes with financial pressure, particularly when paying off your mortgage. An offset account can be a useful tool that can help you shave years off your home loan and reduce the interest you pay. But what is an offset account and how does an offset account work?

Overview:

• What is an offset account?
• How does an offset account work?
  • How is offset account interest calculated?
• What are the disadvantages of an offset account?
• Why do lenders offer offset accounts?

What is an offset account?

An offset account is a common feature of mortgages and home loans in Australia. It is a type of transaction account linked to a home loan. The balance in this account is offset against the outstanding balance of the loan, so you pay less interest on your home loan. An offset account is typically offered with variable rate home loans.

How does an offset account work?

Typically, once your home loan has been approved, your lender will be in touch with you to set up the offset account. The offset account operates like a regular transaction account, allowing the account holder to deposit and withdraw money as needed. This includes depositing your salary or wages, withdrawing cash, paying bills, and using it for everyday expenses.

However, unlike a traditional transaction account, you won’t earn interest on the funds in an offset account. Instead, the money in the account reduces the amount of interest you are charged for your home loan. The savings on interest can be significant over the life of the loan, potentially allowing you to pay off the loan sooner.

How is offset account interest calculated?

The interest on the home loan is calculated on the net balance, which is the outstanding loan amount minus the balance in the offset account.

For example, if the home loan is $300,000, and there is $50,000 in the offset account, interest is calculated on the remaining $250,000 ($300,000 – $50,000 = $250,000).

It’s important to note, the offset account does not reduce your weekly, fortnightly, or monthly repayments. Instead, it allows a greater percentage of your repayments to go towards paying off the net balance of the loan, rather than the interest charged on the net balance.

What are the disadvantages of an offset account?

While offset accounts can offer some homeowners the opportunity to pay off their home loans faster and save money on interest, there are some disadvantages to consider.

Higher interest rates and fees

Lenders may charge higher interest rates or fees for loans that come with offset accounts. It’s important to compare the overall cost of the loan, including any additional fees, to determine if the benefits of the offset account outweigh the associated costs.

Limited availability

Not all lenders offer offset accounts, and the availability of this feature may vary. You may need to shop around and potentially choose a loan with terms that may not be your first choice to access the benefits of an offset account.

Less effective for borrowers with a lower balance

The benefits of an offset account are most significant for those with higher balances. If you maintain a relatively low balance in your offset account, the interest savings may not be substantial enough to justify any associated fees or higher interest rates.

More to budget

Using an offset account can add another layer to managing finances for some borrowers. This is because borrowers need to carefully track their mortgage, offset account balance, and transactions to ensure they are optimising the benefits of the offset feature.

Why do lenders offer offset accounts?

Since an offset account can help you to pay off your home loan sooner and reduce the overall interest you pay, offset accounts can seem too good to be true. So why do lenders even offer this feature?

Competitive advantage

In a competitive lending market, lenders seek ways to differentiate themselves and attract borrowers. Offering offset accounts can be a competitive advantage, as it provides an additional feature that can be appealing to potential customers.

Customer retention

Lenders aim to build long-term relationships with borrowers. By offering offset accounts, they can provide a valuable financial tool that encourages borrowers to keep their accounts and loans with that particular institution.

Attracting high-balance customers

Offset accounts are particularly attractive to borrowers who maintain higher balances in their transaction accounts. Lenders offering offset accounts may attract customers with significant savings, as these individuals can benefit more from the interest savings associated with the offset feature.

Encouraging savings

By linking a transaction account to a mortgage, lenders encourage borrowers to keep their funds in the offset account. This not only reduces the interest payable on the mortgage but also encourages a ‘savings behaviour’, as borrowers see a direct financial benefit from maintaining a higher account balance.

Mitigate the risk of default

Offset accounts can be a great way for borrowers to pay off their loan balances faster and reduce the overall interest they pay throughout the loan. While this is good for the borrower, this can also be good for the lender by reducing the chance of potential defaults.

Should you get an offset account?

While lenders may offer offset accounts for the reasons mentioned above, it’s essential for borrowers to carefully review the terms and conditions, fees, and any eligibility criteria associated with these accounts to ensure that they align with their financial goals and preferences.

If you’re unsure whether an offset account is right for you, consider talking to our mortgage brokering team at Oceania Finance. Our dedicated team will work hard to find you a home loan that will meet your needs and help you to achieve your future financial goals. Contact us today!