Does an offset account reduce monthly repayments?

Does an offset account reduce monthly repayments?

No. Not for a standard principal and interest home loan.

You would think borrowers with savings in their offset accounts should have lower repayments. For a principal and interest (P&I) loan it is not the case.

But there can be a significant interest savings benefit for borrowers with an offset account linked to their home loan.

Most regular home loans will have a required minimum repayment. An offset account is a feature of a home loan – it does not change the minimum repayment. However, it does shift the interest and principal components of a P&I repayment in the borrowers favour.

Here is a video I made that explains how an offset can affect a monthly repayment:

Calculating a home loan minimum repayment – recap

A principal interest minimum repayment will consist of two main components:

“P” for principal the amount the amount owing on the loan reduces by.

“I” the interest. Usually, the main cost associated with the loan.

A lender uses three main variables to calculate a minimum principal and interest repayment for a home loan:

1. Home loan amount – or limit
2. Interest rate
3. Loan term

The bank will determine the minimum repayment that sees the limit paid down to zero at the end of the loan term. In Australia a standard home loan term is 30 years.

How does an offset account change a minimum repayment?

Linking an eligible offset account to a home loan changes the interest charges for each minimum repayment.

In bank language, the amount of the loan balance used for interest calculations in this instance is referred to as “net of offset”.

Normally, when no offset account is linked, the interest charged on a home loan is calculated using the home loan balance.

I the case of a linked offset account, the interest charged is calculated using the home loan balance less the linked offset account balance. This can result in a smaller home loan interest charge.

Both structures require the same minimum monthly repayment.

Here is a screen grab of where I illustrate this in my video, Does an offset account reduce monthly repayments?:

Both structures have the same repayment but the home loan with a linked offset account pays LESS interest and MORE principal.

Interest calculations example – with offset

When an offset account is added there should be less interest charges. And given the minimum repayment is the same, the amount of the principal component increases.

See my example showing how a linked offset balance can change the make-up of a minimum monthly P&I repayment:

Whether an offset account is linkerd to the home loan or not – in this example, both loans require a minimum monthly P&I repayment of $3,597.

If an offset account with a balance of $50,000 is linked to the home loan, the interest charged that month should reduce by $250.

Since the repayment amount does not change – the extra $250 could now be a further payment towards reducing the principal loan balance.

What are the benefits of an offset account?

If there are no monthly repayment changes, you might be wondering what the benefit of an offset account is?

I previously wrote an in-depth article discussing offset accounts here. Borrowers should also be aware home loans with an offset feature can have higher rates and fees compared to more basic products.

From a benefit perspective, extra principal reductions made regularly to a loan balance, can put borrowers on a trajectory that has quite a few benefits. Here are some:

1. Build up equity faster.
2. Save a significant amount of interest over the term of a loan.
3. Save years off the term of their loan

Final word

When I get asked “does an offset account reduce monthly repayments?”, most borrowers want to hear that it does.

I think this has something to do with needing to see a tangible benefit. After all, a smaller repayment and extra cash available each month would be a nice rewards for hard-earned savings.

But a linked offset account does not change the minimum required monthly repayment for a principal and interest home loan – in most instances.

In my experience as a mortgage broker, I encouraged borrowers to look beyond the immediate reward. By saving in offset, and paying down a home loan ahead of the original loan term, the rewards can arguably be greater than some extra cash each month.

The real reward can be no home loan – a mortgage-free life.

If you want learn more about how ‘regular’ borrowers I know acheived mortgage freedom – I put all their strategies in a book. You can download it here.