How an Offset Account Can Reduce Interest in 2024 and Beyond

What is an offset account?

An offset account is usually a transaction account that is separate from—but linked to—your home loan. Offset accounts, when used correctly, can help reduce the amount of interest you pay on your home loan. This is because any amount held in offset reduces the amount of home loan interest your bank can charge.

Both the offset account and the home loan are at the same bank.

Funds held in an offset account are not the same as making advanced payments to your home loan account—these funds are known as available redraw.

There are numerous repayment strategies that can reduce how much interest you pay on your home loan. This article will cover how an offset account, if used correctly, can reduce your interest.

How is home loan interest charged?

Home loan agreements require usually need a minimum amount paid towards the loan account each month. Some of this repayment will pay back the original amount borrowed (principal – the “P”) and some will pay for the interest (the “I”) the lender is entitled to charge. Most borrowers make principal and interests (P&I) payments.

Banks generally calculate interest charges on home loans each day you owe them money. Interest costs are tallied up and usually charged to your home loan account once a month.

A home loan statement might detail the repayments and interest charge like this:

Before buying a home, savers are often on the lookout for savings accounts that “pay” interest.

Once you have bought a home and have a home loan the tables have turned. Interest used to be a good thing when you were earning it – now it has moved from the credit column to the debit column. While saving money may still be part of your financial goals it becomes less about earning interest than avoiding paying it—as much as possible.

How does an offset account work?

When your bank links your offset account to an eligible home loan, any savings held in your offset account can reduce the amount of interest you pay on your home loan.

An offset account does not earn interest, but it can reduce the interest paid on a home loan.

At a minimum your lender will need two accounts linked:

Home loan

• Amount you own the lender
• This is usually a variable rate home loan, but some lenders allow fixed rate home loans to be offset

Transaction account

• Often referred to as an offset account once linked to a home loan
• Holds money for general transactions
• Keep savings here that you wish to control and have available
• Does not usually pay any interest on savings

Without an offset account, a lender will charge interest on the amount owed to them at the end of each day – plain and simple.

With an offset account – Instead of the lender charging interest on the home loan balance owed to them, they deduct any balance held in the transaction (offset) account before making these calculations. In practice, bulk savings as well as money you might need on a daily basis can be offset to reduce interest charges.

How much interest can an offset account save?

A home loan of $600,000 with $30,000 offset could see $93,000 saved over the loan life in addition to reducing the loan term.

Here is a simple example.

The home loan of $600,000 illustrated below is only being charged interest on $570,000. Why? Because there is a separate but linked account with $30,000 that is offsetting any interest charges. You might use that money at some point (or not). Each day the funds are offset you are reducing your interest charges.

So how does an offset work in dollar terms? This calculation illustrates the interest savings (it ignores fees) by comparing having $30,000 offset to $0 offset for the following interest cost examples:

• $600,000 loan amount
• 30yr loan term
• 5% interest rate
• Minimum monthly principal and interest repayments

An offset account balance will not change the minimum monthly repayment you owe the lender, but it can make a significant difference to the interest you pay a lender. The savings equate to $125 in reduced interest cost in the first month.

Over the first year the interest is reduced by $1,535 by having the $30,000 offset.

This translates to over $93,000 saved over the life of the loan as well as a reduction in the loan term. Importantly we have provided this example based on minimum repayments only. No extra repayments at all – just a consistent balance of $30,000 sitting in offset.

These examples are for illustration purposes only and do not constitute advice. Whether or not an offset is a product suited to your needs is for you to work through with your mortgage broker or lender.

Key offset account considerations

You need to weigh up a few things before you decide an offset home loan is a good product for you. Below is a list of things to consider when deciding if an offset account is worth it.

Offset vs Redraw

Working off the same example, you could put $30,000 savings in your loan account as an advanced payment (known as redraw) and that will have the same interest calculations as $30,000 sitting in a linked offset account.

If you still want to access this money in redraw, check on whether this is possible and whether it comes with fees or restrictions.

But what if you need some of this money to pay for things like gym and groceries? Perhaps you can only spare $20,000 because you need $10,000 to stay in your transaction account for spending. This means, out of $30,000 in available cash only $20,000 is sitting in redraw and the other $10,000 is not helping reduce you home loan interest charges.

This is one type of analysis you might do with your mortgage broker or lender to put a figure next to the offset vs redraw comparison. This analysis could also assess whether it is worth any fee or rate premiums for an offset facility.

What if I turn my home into an investment property?

Not all home loans are the same. Surprisingly, some home loans are worth keeping and not paying down. While mortgage brokers can assist with arranging different loan structures, any repayment strategies with an investment angle should be adopted in consultation with advice from a qualified tax accountant.

Many borrowers focus on paying down their home loan as quickly as possible and for the most part that strategy is sound. However, if you want to turn your existing home into an investment property at some point in the future then it might be worth considering an alternative repayment strategy.

You might have heard of negative gearing? It refers to the many tax-deductible expenses an owner of an investment property can use to help reduce income tax in Australia. Well, the interest charged on a home loan for an investment property is one of these expenses.

It is important to recognise that when you get a home loan the purpose of the loan is established. So, when you buy your home using a loan then the purpose is clear – the loan is for that house. This loan could be useful to you in future if you turn your home into an investment.

An offset account can enable borrowers to “preserve” much of their debt without paying all the interest that comes with it.

Rather than paying down a home loan, some borrowers save all extra money in an offset account – this allows them to offset the interest and thus keep borrowing costs down. They can take the money saved in offset to help buy a new home while they turn their home into an investment property with a useful loan attached to it.

Common home loan packages

Offset accounts are often presented as part of a package of products. These sometimes include additional home loan interest rate discounts, credit card fee waivers and reduced insurance premiums. If you have an offset account, it might be worth understanding how an offset works within a home loan package.

Rate and fees

Based on projected savings, rates and fees you can analyse if it worth having an offset account compared to alternatives. Your mortgage broker or lender can help with this.

Access to funds

Offset accounts allow access to funds. Not all home loans allow access to funds paid in advance known as redraw.

Are you a good saver?

Much of the analysis of offset account benefits is based on existing or projected savings. Be realistic when estimating future offset balances.

Account holders for offset accounts

The account holding on these linked accounts is all important. In general, the account holders on the offset accounts should match the account holders on the home loan it is offsetting. There are lender-specific variations to this.

Types of offset accounts

It is worth gaining an understanding of some of the offset terms. Just as it is with home loans – not all offset accounts are equal.

100% Offset

This means that 100% of the funds held in your linked offset accounts are accounted for in the calculations to offset your interest. Ideally there will not be a minimum balance required.

This type of offset account is commonly linked to a variable loan but there are some fixed loan products that can also be 100% offset.

Partial offset

This is a product some lenders use, mainly in relation to home loans with fixed rates. Check the proportion that is offset as it might be under 50% which changes the calculations significantly.

One offset account per home loan package

Even if borrowers have more than one loan at a lender, they can only have one offset account so they might need to reconsider if they wanted multiple offset accounts.

One offset account per home loan

This can be helpful when you have more than one home loan eligible for an offset. Assuming rates and purpose is the same across all loans then some reasons borrowers will use this function is:

• You have offset the total loan balance and so need to find a place to put your extra savings. This is where another offset account linked to another loan could see you continue to gain an offset benefit from the extra savings.
• Perhaps you like budgeting out of several accounts or buckets. If your savings are across a couple of accounts that are offset, then you will still benefit.

This is how it can work in practice. Each loan has a linked offset:

Multiple offset accounts – Cumulative

This has been an innovation in recent years that has provided opportunity for borrowers to offset their savings across multiple offset accounts and have the cumulative balance offset one home loan account. Some lenders limit the number of cumulative offsets to 10 but that should satisfy most borrowers.

Final word

Offset accounts have many benefits, and used correctly the amount saved through reduced home loan interest can really stack up over the years.

Offset accounts are not for everybody. They need to be considered on balance with alternative product options in line with borrower needs and objects. A mortgage broker is well placed to guide you through a home loan selection process complete with comparisons that include offset options.