Traditional wisdom in the Australian mortgage industry is that when you’re comparing home loans, you should always choose one with an offset account – a savings or transaction account linked to your home loan. Any money deposited in this account is used to “offset” your mortgage when calculating your interest charges.
For example, if you owe $500,000 on a mortgage, but have $100,000 in your offset account, you’ll be charged interest as if you only owed $400,000. This can help make your home loan repayments more affordable, allowing you to potentially save money and pay off your mortgage faster.
So, why wouldn’t you want an offset account? Well, it is a truth universally acknowledged that you get what you pay for. Home loans offering extra features, benefits, and other bells and whistles (including offset accounts) are more likely to charge higher fees and/or higher interest rates than no-frills options.
While an offset account can help you save money by shrinking your interest charges, if those interest rates and fees are higher, you could still be worse off overall.
For example:
According to RateCity research, a variable owner-occupier home loan with an offset account (Loan A) has an average interest rate of 4.53% and charges an average annual fee of $189.66.
On the other hand, a variable owner-occupier home loan with no offset account (Loan B) has an average interest rate of 4.31% and charges an average annual fee of $27.96.
Used to take out a $300,000 loan for example, Loan A would end up costing $39.03 more per month over a 30-year term compared to Loan B. That may not seem like much, but over 30 years it adds up to $18,902.44 in extra costs (including fees).
One way to calculate if an offset account is worth it is to compare your home loan’s annual cost in interest and fees to how much you’re likely to save per year. If it looks like you’ll pay more than you’ll save, it may be worth considering a more basic home loan with a lower rate and no fees.
For example:
Based on the previous example, RateCity calculates that if you took out a $300,000 mortgage with Loan A and kept an average of $5000 in the offset account over its full term, the interest savings would mean you’d pay off the mortgage 12 months sooner than you would by choosing Loan B, but you’d still pay $4718 more in total interest and fees.
However, by keeping $10,000 in Loan A’s offset account, you’d pay off the mortgage two years sooner, and save up to $8616 in total compared to Loan B with no offset account.
If you kept $50,000 in the offset account, you could shave more than eight years off Loan A’s term, and save $91,564 in fees and interest compared to Loan B.
It’s also important to check if a mortgage has a partial offset account, which only uses a percentage of its money to offset your home loan. For example, if you have a $500,000 mortgage, and $100,000 in a 50% partial offset account, you’ll be charged interest as if you owed $450,000. You’d still save money in interest charges, but not as much as with a full offset account.
Some borrowers maintain a high enough balance in their offset accounts to “break even” by having their salaries paid directly into their offset account, and only transferring the minimum amount they need for everyday expenses into a separate transaction account.
One potential alternative to an offset account is making extra mortgage repayments, which can reduce the principal owing on your home loan, and help shrink your interest charges. However, this may lock your money into your loan, making it harder to access if you need to pay for a surprise expense, whereas the money in an offset account is often a just a withdrawal away.
Some home loans include a redraw facility that lets you withdraw extra repayments from your mortgage (though not your regular mortgage payments) if you need the money back in your pocket. Keep in mind there may be limits on how much you can redraw, or your number of redraws per year, and you may also need to pay redraw fees.
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