Understanding how your offset account works can help you lop years off your home loan. Photo: Yuri Arcurs People Images.
An offset account can be your secret weapon for cutting years off your mortgage and saving hundreds of thousands in interest – if you know how to use it strategically.
One Canberra expert says being in the know on how your account works and adopting certain habits can have a significant impact on your long-term bottom line.
“A lot of people ‘set and forget’, but there are some fairly simple ways to be more aggressive if you’re keen to save money and shorten the lifespan of your mortgage,” Clarity Home Loans training director Rob Garth says.
Put simply, an offset account is a transaction account linked to a home loan, allowing the account balance to reduce the amount of interest paid on the loan.
The first point to note is that interest is calculated daily and charged monthly, meaning every dollar you have in your account on any given day helps reduce the interest charged.
“Obviously we all have expenses, but the goal is to leave as much in your offset account as humanly possible for as long as possible,” Rob says.
“Some people use credit cards to pay for expenses and clear it each month, but be careful – this can be a financial trap if you’re not diligent about clearing the debt on time.
“Simpler steps might include timing direct debits for the day before your fortnightly salary is due to go back in, so the balance stays higher and the interest charged is less. It all adds up.”
The savings are nothing to scoff at. A $400,000 loan with a $40,000 offset account saves $167,000 in interest and shaves 5.5 years off a 30-year loan term, according to Rob.
“If you manage to grow that account by $100 a week, you can knock off another $100,000 off your interest, and lop another six years off the loan term,” he says. “Your 30-year loan is now down to 18.”
Clarity Home Loans training director Rob Garth says clients can collect significant savings with a few savvy moves. Photo: Clarity Home Loans.
Some banks allow clients to have multiple offset accounts, which can help with budgeting.
Separate accounts for household expenses, transport, entertainment and so on can grant you more control.
“It’s called ‘bucket budgeting’, and this approach got bigger off the back of the book The Barefoot Investor by Scott Pape. It allows a person to filter funds into certain accounts at certain times, depending on the different timing of various expenses,” Rob says.
“We know every bill is on its own cycle. Rego might be quarterly but insurance might be monthly, while other expenses are daily, weekly or even ad hoc. Separating those expenses out into multiple offset accounts, the savings tally up to reduce your charges.
“Some people say the visual representation of bucket budgeting, as opposed to spreadsheeting, also helps them stay within their budgets.”
Despite the major potential for savings, offset accounts only make sense if you have enough savings to take full advantage of the benefits. Some also attract higher fees or interest rates, and not all loan structures come with an offset account option.
When deciding if an offset account is for you, consider your long-term plans.
Those without offset accounts can still put extra payments into their loan. These payments sit in a redraw facility and have the same impact as funds in an offset account in terms of interest recalculation or reduction.
However there’s a potential pitfall to this if the property you are purchasing is a stepping stone property such as a unit, which will eventually become an investment property when you upgrade.
In this instance, an offset account can help protect the tax deductibility of that unit.
“If you want to later use the money you have in a redraw facility to buy an owner-occupant house, you change the purpose of your loan – it effectively becomes an investment loan. Come tax time, you can’t claim interest on it,” Rob says.
“Using an offset instead provides a much higher tax deductibility on the loan, so you get a much bigger tax return at the end of each year.
“Setting this up correctly at the start could save you tens of thousands of dollars over the lifespan of the loan.”
For more information visit Clarity Home Loans.
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