With inflation on the rise, just the idea of buying your own home can sound financially draining. For this reason, homeowners are familiar with the concept of mortgages. Mortgages are increasingly common because of the reassurance they provide.
A lender is reassured because the property serves as collateral. Meanwhile, the buyer is at ease due to the nature of the periodic payments, which gives them time to allocate expenditure effectively.
Offset accounts exist to make things easy, but it can get tricky. In this article, we will explore how you can navigate these challenges and make the right choice for yourself.
What Is an Offset Account?
An offset account is much like a high-interest savings account. The difference is that instead of earning you interest on your savings, it saves you interest on your loan repayments.
That is not to say that the money in an offset account is a repayment of the loan; instead, it is a reduction in the loan amount outstanding for interest calculation purposes.
As an example, let’s say that you have $250,000 as your mortgage amount, with an interest rate of 4%, and your offset account balance is $15,000. Without the offset account, you will be charged interest on the total amount of $250,000, meaning you will have to pay $10,000 in interest.
However, with the offset account, your gross balance becomes $235,000, so the interest payable decreases to $9,400, saving you $600. In addition, unlike savings accounts, you can withdraw money from this account when required.
Suggest Reading: Learn Why Smart Investors Use a Mortgage Offset Account to Scale Faster in Soho’s article.
Choosing the Right Account
When selecting an account to help you pay for your mortgage, it’s essential to recognize that not all accounts are created equal; they come with various features tailored to different financial needs and circumstances.
Before choosing an account, you have to ensure that the benefits it brings you are higher than those of any alternative options available. Here is what you should consider before choosing an offset account for a mortgage:
1. The Interest Rate on Mortgage
Interest rate is crucial when calculating offset accounts for mortgages because it directly impacts savings. Commonly, the advantages of an offset account become more pronounced when the interest rates are high. High interest rates save you more on loan repayment due to your offset account balance.
Taking the example mentioned above, if the interest rate was 6% instead of 4%, your interest payment without an offset account would be $15,000, while that with an offset account would be $14,100, saving you $900 instead of the former $600. If you are inclined to purchase relatively expensive homes with higher mortgage interest rates, consider setting up the account.
2. Financial Habits and Goals
Offset accounts have been popular since way before the inflationary problems following 2022. In fact, in 2015, when financial situations were less dire, Australia’s offset account balances still amounted to a substantial $90 billion. A significant reason for this, and ultimately their prevalence to this day is because these accounts offer liquidity.
You can withdraw the balance when needed, unlike savings accounts. For those wishing to keep their savings accessible for emergencies, offset accounts have been convenient.
However, remember that any withdrawals will affect your savings on loan repayment. If you do not have a consistent savings balance, the benefits of an offset account will be limited.
You should also look at your financial goals and ensure that your account fits within those. If your primary goal is to reduce mortgage interest and you value having immediate access to your savings, an offset account is suitable.
However, if building an investment portfolio or saving for a large purchase is more critical, you might be better off depositing funds in a high-interest savings account.
3. Fees and Charges
This is the most direct approach to determining whether you should go for an offset account or not. Some of these accounts charge a regular fee on a monthly or annual basis. Similarly, you might have to pay transaction fees or account setup fees.
These fees can eat into the savings you have achieved from the account, reducing net benefits. Compare the fee structure with the interest rate to assess net gains via savings and evaluate whether they are worth it. Different banks offer varying fee structures and benefits, so sort through your options and choose wisely.
4. Type of Offset Account
Once you have made up your mind about the offset account, you have to choose which one. These are usually categorised into two types: full offset and partial offset.
In a full offset account, every dollar deposited into the account is a dollar deducted from the loan repayment account. All the numerical scenarios explained above are examples of this type of account.
On the other hand, when it comes to a partial offset account, only a portion of the balance in the account is used to reduce the mortgage interest payment. These accounts have a specific offset rate that determines the reduction in mortgage balance.
For instance, if a partial offset account has a 50% offset rate, $10,000 in the account would only reduce the mortgage balance by $5,000. Full offset accounts are generally more popular. However, you might opt for a partial offset account when you wish to see a repayment reduction without a loan term reduction.
Consulting Professionals: The Way Out
You might face numerous complexities when setting up an offset account. You will have to assess its compatibility with your mortgage, review the account terms and conditions, and consider the tax implications. Understanding how different accounts impact your long-term financial goals and comparing them with alternatives will be challenging.
Whether you are pondering over your mortgage or renting out your home, having a professional backing you up is always helpful. Consulting a financial advisor or a mortgage broker can provide you with personalised advice based on your circumstances and help you navigate complex financial decisions. As a result, you can optimise your overall strategy for maximum gains.
Endnote
Offset accounts are exceptionally useful, but that is only when they are aligned with your needs. Remember, making the right choice is extremely important for your financial well-being. The tips above can ensure that the account you choose is ideal for you.
