Reducing the time it takes to pay off your home loan takes more than just a low rate, the features and benefits attached to the loan play a very important role.
Many Australians don’t understand how to use their home loan features to help pay off their loan sooner, and one of the most effective ways to do this is by taking full advantage of an offset account.
The term ‘offset account’ and how it works is not always well understood, so it often gets overlooked when comparing home loans.
However, using an offset account could save you thousands of dollars in interest on your home loan and essentially helping you pay your loan off sooner.
You can get your wage deposited straight into it and take money out as you need it without incurring any fees or charges.
But before you jump in and ask to add an offset account into your home loan, you should understand first the two types of an offset account – partial and 100 offset account.
A partial offset is further categorised into two: portion of the balance and discounted rate.
If you choose the portion type, your bank will offset a part of your balance in an offset account to bring down the principal of the loan and the interest you need to pay.
For example, if you take a home loan with a 20% partial offset, $10,000 of your $25,000 will be used to reduce the loan amount. So for a $250,000 home loan, you would only pay $240,000.
If you choose the discounted offset, your bank will offer a discounted interest rate on the home loan balance of your offset account.
For example, if you take a mortgage with 4% interest and your bank offers you a 1% discount, you only need to pay 3% in the balance in your offset account.
As the term implies, 100% of the balance in your account will be offset against your mortgage.
In the same scenario above, the entire $25,000 will be offset against your $250,000 loan, and you will only pay interest on $225,000.
How does an offset work?
Put simply, the money in your offset account is used to offset the amount owing on your home loan. For example: If you have a home loan of $500,000 with $50,000 in an offset account, you will only be charged interest on the remaining $450,000.
So how much can you save?
Considering how you use it, it is possible to make a real dent in your debt. It’s easiest to think of an offset account as simply an account where you can park your savings, except the return is greater.
For example, instead of earning, say, 2.80%p.a. on your savings of $30,000 in a regular savings account, you could save 4.50%p.a. in interest on $30,000 of your home loan. (Assuming your home loan rate was 4.50%p.a.)
Home loans bundled with an offset account
Most variable rate home loans are available with 100% offset account.
But some banks that offer split loans also come with an offset account, so you can still reduce the amount on your variable portion while still maintaining a fixed rate portion of your loan.
For example, let’s say you decided to fix $50,000 on your home loan and leave $150,000 on variable.
Because you have $25,000 in an offset account, you will only be charged interest on $125,000 of the variable portion.
What is the difference between an offset account and an extra repayment facility?
Extra repayment or redraw facility is another option to reduce the amount of interest you pay for your mortgage.
This feature will allow you to add more money to your repayments. But is it better compared to an offset account?
An offset account can reduce the interest you pay as well as the life of your loan. It allows you to redraw the amount in the offset account without paying extra account keeping fees.
It is also tax-free because the money you saved by reducing your interest on your loan is not considered income.
But remember, an offset account doesn’t really reduce the loan principal, and you can be charged a higher fee for having the offset option added to your mortgage.
On the other hand, an extra repayment facility can also reduce the interest you pay and the term of the loan. It is usually available with fixed-rate mortgages and can reduce the loan principal.
However, if you choose to add a repayment facility, you may need to pay a fee for dipping into extra repayments.
Some advisors also believe that a repayment facility is also less flexible because your loan provider may limit the amount you can redraw.
So which feature should you add to your home loan?
Extra repayment facilities and offset accounts are both helpful additions to reduce the balance of your loan.
To be sure, you can consult your mortgage advisor and ask about the benefits of each feature and how it can be applied to your situation.
Also, don’t forget that there are other loan features that you can also explore, such as home loan top-ups and repayment holidays.
Three tips to take advantage of your offset account
1. Use your offset account as your primary bank account.
Why sign up with a mortgage that comes with an offset account if you will not use the feature?
To maximise the benefits of this account, you can use it as your primary bank account.
This will help you bring more cash influx to the offset that will further reduce the interest on your loan.
2. Deposit your salary into your offset account
Because an offset account can reduce your mortgage interest, you need to add more money into your account.
Take note that your balance will be offset daily so a regular deposit through employment can further bring down your repayments.
So try asking your employer to use your offset account to receive your salary.
3. Use your credit cards.,
If you have the discipline and reasonably practical for you, try paying for your everyday purchases with a credit card.
This will help you make sure that you have the most cash in your offset account.
Just don’t forget to pay your card balance in full at the end of the month to avoid incurring higher interest rates and fees.