Navigating the Maze of Loan Options - Offset Accounts

This is the second in a series of short posts to provide some insight into the world of home loans.

Navigating the maze of loan options.

It’s not easy picking the right loan for you and your situation. There are many considerations, and while a big one is the interest rate, it is not the only factor to consider.

What is an offset account and do I need one?

Ann offset account is a type of deposit account that is linked to your loan.

The interest on your loan is calculated daily on the outstanding balance (the principal) and added to the loan each month. If you have an offset account your loan repayments remain the same but the interest is calculated on the difference between the loan balance and the offset account balance.

For example, if you have a loan of $520,000 and an offset account with $60,000 instead of paying interest on $520,000 you pay interest on $460,000.

Each loan repayment you make for the life of your own is made up of two parts – one is the interest and the other is a repayment of part of the balance. In the example above, at the beginning of the loan, a repayment of $2965 would be approx. $2400 interest and $565 principal reduction. With $60,000 in the offset account, the same repayment of $2965 per month is then approx. $2100 interest and $865 loan repayment. So by having funds in the offset account you are reducing your balance and reducing the amount of interest being paid to the bank without paying extra out of your own pocket.

The result is that you pay your loan off sooner and save a lot of interest without actually paying extra off the loan. It is also a practical way to structure the loan – you could arrange for the loan repayments to come out of the offset account, and deposit your own funds in there each pay to keep the balance as high as possible. You can often have multiple offset accounts, eg a transaction account each whose balances also reduce the interest payable on the loan.

The downside of an offset account is that these accounts often have a higher interest rate than standard loans as well as an annual or monthly fee. So you need to be sure that the benefit outweighs the cost.

Would you be better off using your offset funds as part of your deposit and borrowing less in the first place? Generally - yes you would. However this depends on your plans and goals. You may have a plan to spend that $60,000 in a few years time perhaps to renovate or buy a new car. Some people prefer to have those funds available as an emergency fund rather than use all of their savings towards the purchase. The offset account could start off with a nil balance and be used as a savings account.

Using an offset for investing

Another good reason to have an offset account is the scenario where someone has bought a home, and has a future plan to rent that home out as an investment and buy a new home.

Example - no offset - You've been making extra repayments as often as possible and the loan of $520,000 has been repaid down to $300,000. You decide to buy a new home at a cost of $800,000. You take out a loan for your new property so you end up with an investment loan of $300,000 plus a home loan of $800,000. Interest payable on an investment loan is tax deductible.

Example - with an offset - The loan of $520,000 has been repaid down to $420,000 and any extra funds have been put in your offset account which now has a balance of $120,000. You decide to buy a new home at a cost of $800,000 using the $120,000 from your offset as a deposit. You take out a loan for your new property so you end up with an investment loan of $420,000 plus a home loan of $680,000. Interest payable on an investment loan is tax deductible so in this scenario you have maximised your tax deductions. Please note these are examples for illustrative purposes and should not be taken as advice. Please speak to your financial planner or accountant to make an informed decision.

How much should be in my offset account to make the benefit worth the costs?

Per the above table, there are many different offset options out there with these examples showing real life interest rates as at 16th June 2023. If you have an offset account and you are paying a higher interest rate - make sure that you have enough balance to justify it. Or reach out to me - maybe I can get you an offset like the green rows above where there is no difference in interest rates.