An offset account can be critical for some borrowers but it doesn’t always save money
There are certain circumstances where an offset account attached to your home is not only nice but critical for future taxation reasons. This usually only occurs when you intend to purchase a property to live in and then in the future rent it out. It is vital that you get good advice before arranging any finance where this is a possibility.
Otherwise if you have a large salary or regular large lump sum payments, a 100 percent offset can be very useful ( partial offsets are almost always pointless). However for many mortgage holders who don’t have slabs of spare money to park in their offset account the benefit can be minimal or even worse.
For investors with no other non-deductible debt an offset account can be a useful way to deposit your funds and so reduce your interest bill but still have the freedom to withdraw those funds for personal use and not contaminate the ‘purpose of the borrowing’ as far as the ATO is concerned. If you have non-investment debt on your PPOR (primary place of residence) then an offset on your investment loan is almost always inappropriate.
How does an offset account work with my home loan?
First and foremost understand that a loan that lets you deposit and withdraw money into your home loan is NOT an offset account. It may be similar in outcome but particularly where it comes to how the ATO views your mortgage an offset account is very absolutely NOT the same thing.
An offset account is a completely separate account, usually a transaction account that works just like a savings account. However instead of earning 1 or maybe 3 percent interest – the money in your offset account is balanced against the amount you owe on your home loan and effectively reduces the net amount that you owe and saves you 5 or 6 percent in interest. Think about it – if you have $10,000 in your savings account and earn 4% interest that means you earn $33.33 per month – which is income on which you have to pay tax and at 30 cents in the dollar means you clear $23.33 so effectively you make 2.8 percent.
When you have a 100 percent offset account with $10,000 balance and a home loan paying say 3.75% interest (home loan interest rates are always higher than deposit rates) – the $10,000 saves you $48 per month, but because it isn’t income – it isn’t taxable and so your money is working much harder. Of course this really only applies when the offset account is secured by owner occupied home loans, but an offset can also be useful on investment home loans.
Meanwhile, just like a savings account you can deposit and withdraw the funds at any time for any purpose – they are your funds.
Remember however that an offset account can be expensive in terms of fees or higher interest rates charged on the home loan and they are often not suitable particularly where your discretionary income is low. Why? Because you often pay more interest or higher fees. However there are some lenders who at times offer a competitive home loan with no ongoing fees and a free 100% offset attached.
Of course there are home loans that work like an offset where you deposit your wages and withdraw money as you need directly into and out of the home loan – we call these ‘all in one’ accounts. As long as the taxation implications mentioned above don’t apply to you then these are often as good if not better than an offset account as they usually come with lower interest rates and lower fees.