How to get the most from your offset account

An offset account is a widely sought after feature of home loans in Australia. But what is it? How does it work? And is it really worth paying extra for?

What is an offset account?

An offset account is a transaction account linked to your home loan. Instead of paying interest, the balance is ‘offset’ against your home loan balance so that it reduces the interest charged on your home loan.

Why should I care?

It can save you money.

If the bank paid you interest on your deposit, you’d have to pay tax on the income, which reduces how much you get to keep.

So $1,000 deposited in a bank account paying 4% interest, would pay $40 for the year. For the average income earner, tax at 34.5% reduces this to $26.20.

On the other hand, the same $1,000 deposited in an offset account against a home loan with an interest rate of 5.0% would reduce the interest paid on your loan by $50 – an extra $23.80. So what's not to like?

Depositing money in your offset account is economically the same as paying down the loan but gives you the flexibility to withdraw it again.

Offset accounts can potentially save you lots of interest and reduce the time to repay your home loan.

But offset accounts usually cost more

A home loan with an offset account will usually cost more than a ‘no frills loan’. They may have a higher interest rate, a monthly or annual fee or come as part of a package.

Not all offset accounts are created equal

Some offset accounts require you to maintain a minimum balance to get the benefit. Others may not give you full credit for your balance.

If your loan is from a lender that isn’t an Authorised Deposit Taker (ADI) –you’re not getting a real offset account.

If the name doesn’t include the words ‘Bank’ or ‘Credit Union,’ they’re probably not an ADI and you're likely to be getting a disguised redraw account.

This can make a big difference if you are claiming a tax deduction for your interest.

Checklist for choosing an offset account

100% offset (not a partial offset).
Easy access to your offset funds
No balance limit or penalties for withdrawal.
Can you get multiple offset accounts linked to one loan? This can be great if you're saving for a few goals at the same time (such as a holiday, a wedding, a new car or even a new home or investment property).

Do you need an offset account?

You will usually only gain a net benefit if you keep a high average balance in the account.

How much will depend on the interest rate on your loan, the interest rate you could earn on a deposit account, the amount owing on your loan, and your marginal tax rate.

Right now typical home loan rates are around 5%, while with a little work you can find a deposit account with a bank paying 4% or more.

For example, if you are an average earner and owe $500,000 on your home loan at 5.0%.

Then a $395 annual fee will require an average offset balance of $16,597 to break even.
A $10 a month offset account fee will need an average offset balance of $5,042 to break even.
An extra 0.25% interest rate on your home loan will cost you $1,250 in additional home loan interest and would require a whopping $47,529 to break even

If you don't keep a regular high balance in your offset account you may not get value from the extra cost.

Here are three ways to get the most from your offset account

1. Deposit your salary into the offset

Combine a debit card and online bill payments with your offset account and have your salary paid into it. This way you can use it as your main transaction account and save.

Interest is calculated daily on your home loan, so every day the money stays in your offset account you save. This is true even if the balance goes up and down with your day to day transactions.

2. Add a credit card and turbocharge your savings

The more money you keep in your offset account, and the longer it stays there, the more you will save.

If you use a credit card to pay as much of your everyday expenses, you can benefit from the interest-free period and keep the money in your offset account for longer.

You might also get frequent flyer points if you choose the right card.

The trick here is to make sure you pay your credit card bill in full and on time. The interest charged on your credit card will be so much higher than the rate on your mortgage.

Check that you are not being charged a surcharge for paying your bills by credit card.

This hack takes discipline. If you spend more because you use a credit card or miss a credit card payment – even by a day – you could see your savings vanish.

3. Put any savings straight into your offset

If you are setting aside money for lump bills – like your car registration or insurance or annual holiday – use your offset account.

4. Park a windfall while you work out what to do

If you win the lotto, receive an inheritance or otherwise come into some cash, put it in your offset account while you work out what to do with it.

5. Make sure the balance in your offset never exceeds the balance on your home loan.

If you do, you won't get any benefit from the excess and you’d be better off transferring that to a standard high-interest savings account.

So what should I do now?

If this all seems too complicated or time-consuming, a good broker can sort it out for you.

How to get the most from your offset account