Understanding mortgage offset accounts

A mortgage offset account generally works by offsetting (or ‘deducting’) your savings balance in this account against the balance in your home loan account, rather than earning interest on your savings balance – as is typical in a normal transaction or savings account. This in turn reduces the total interest you pay on your home loan and thus the monthly interest payments you need to make on your home loan term.

How it works

For example, if you have a savings balance in your offset account of $20,000 and a balance of $200,000 in your home loan the interest on your home loan is calculated on $180,000 – assuming you had a 100 per cent offset account. In this case, every dollar in your offset account is offset against the balance in your home loan account.

If you had a partial offset account, for example of 40 per cent, your loan interest would be calculated on a balance of $192,000. This represents 40 per cent of the example $20,000 savings balance in your offset account.

It follows from the above 100 per cent example that a 30-year-old with a $350,000 home loan could shave six years and six months (78 months) off a 30-year (360 months) home loan term by maintaining a savings balance of $50,000 in his or her offset account. In other words, the 30-year-old would pay off his or her mortgage loan at age 54 rather than age 60 – a significant benefit in anyone’s language.

Another significant potential savings benefit for home owners – if not investors – is that in most cases the ATO does not view an offset account as a vehicle to earning interest income. Investors are usually on an interest-only home loan and thus have little motivation to reduce the tax-deductible interest they pay. Homeowners, by contrast, want to pay as little interest as possible on their home loan in order to pay it off as quickly as possible.

Drawbacks for some

Unfortunately, the reality for many borrowers is that they save negligible interest and few – if any – years off their home loan, says mortgage broker Medine Simmons of MFSimmons Property Investment Services. The main benefit of an offset account for these borrowers is its convenience as a stand-alone interest-free transaction account linked specifically to their home loan, she said.

They use it almost solely to keep funds ‘at call’ for their living expenses, she continued. They may inadvertently manage to save a little bit on their home loan interest repayments in the few days that their salary remains in their offset account before they use it to pay off a separate credit card account balance and other expenses.

Often these borrowers don’t have a sufficient savings balance in their offset accounts to even offset the annual fee of between $300 and $400 on average it costs to keep an offset account, said Ms Simmons. A savings balance of $8000 in their offset account would be required to be able to save the equivalent of the $400 annual fee in their home loan account.

It would be more economical for these borrowers to switch out their offset account – which are typically available as part of premium-priced Professional Home Loan Packages – and into a basic home loan product and a normal transaction account, she advised.

An offset account is also generally offered to people on a variable home loan. Ms Simmons said she knew of only one lender that offered an offset account on a fixed home loan.

It’s worth thinking about getting a mortgage offset account, but don’t take the plunge unless you’re sure you have the funds for it.