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An offset account is a transaction account linked to your mortgage. The balance in the offset reduces the loan balance by the same amount. Here is what you need to know abut how having an offset account will help you pay off your home loan faster
If you can reduce the interest payments in your home loan, you speed the repayment of the principal amount and accelerate the pay-out of the mortgage. This boosts the equity you have in your property and gives you options in your further investments. One way to speed the repayment of your home loan and increase your equity is with a ‘100 per cent offset account’.
The offset account is a dedicated transaction account that’s linked to your mortgage by your lender. You deposit all of your household income into this offset account, which reduces the balance in your loan account by whatever the balance in the offset account is. Let’s say you borrow $400,000 to buy your property on a 25-year Principal and Interest (P&I) loan at 5 per cent interest. Your monthly repayment is $2,338. If you put $10,000 into your offset account, you immediately reduce the loan balance to $390,000, and therefore, you reduce the interest you pay because there is a smaller principal on which to charge interest.
When all your household income is deposited into the offset, you can reduce your interest and boost your equity by maintaining a balance in the account. Typically, you’d have a daily transaction account linked to the offset, into which you shift your income as you need it, for bills, house and car costs etc. But you leave what you can in the offset to reduce your interest bill. If you and your partner put your monthly income of $10,000 into the offset account, the balance reduces your mortgage principal, less the money you shift into your transaction account to pay your bills.
The most important goal with an offset account is to ensure something extra is left in the offset account each month after you’ve paid your bills. The couple that deposits $10,000 into their offset account each month will not make a lot of headway if all of the $10,000 is withdrawn each month. Here’s another way to run your offset account: once the balance in the offset account builds to a sustainable level, you then transfer surplus funds directly into the home loan.
Let’s say your offset balance is consistently over $20,000. You could make a lump sum reduction of $20,000 on your home loan. The $20,000 would still be available via redraw but it would represent less of a temptation for spending if is deposited in the actual loan. Obviously, the offset account favours borrowers who are disciplined in their spending because the true benefits are experienced when there is always a balance in the offset account. Which means depositing more than you spend. Those who optimise an offset account to build wealth are usually those who run household budgets.