Mortgage Offset Accounts

A mortgage offset account has also been referred to as an offset home loan, an interest offset account, or simply an offset account. All of these terms refer to the same thing: a mortgage that is linked to a bank account. Crucially, the interest that you owe toward the home loan is based on owed balance of the loan minus the balance in the bank account.

How Does an Offset Account Work?

You can use the account just like a standard bank account. You can deposit and withdraw funds, write checks, use an ATM, and access your account online. When the bank calculates your interest, it is as though all of the money in the offset account has already been applied toward the loan.

As an example, if you owe the bank $500,000, and you have $10,000 in your offset account, the interest that you owe will be based not on the full $500,000, but on $490,000.

How Can the Bank Do This?

Why is the bank able to do this? It comes down to the way that banks work. When you make a deposit at the bank, the law says that they have the right to lend out a specific percentage of those funds and earn additional interest on them. Every time that you give money to the bank, whether it is to pay off a loan or simply to make a deposit into your bank account, you are actually giving the bank access to those funds.

For this reason, the bank doesn’t really see the funds any differently. Whether you are paying off a loan or making a deposit, they can use the funds that you give them in order to make additional loans and earn additional interest on them.

Does it Make Sense to Use an Offset Account?

An offset account is not the perfect solution for everybody, but for certain strategies it can be extremely beneficial. The important thing to keep in mind is that it is all relative. If you could earn more interest by putting the money into a savings account than you can save by putting it into an offset account, it doesn’t make a great deal of sense.

In reality, the amount of interest that you can earn from a savings account is usually very small in comparison to the interest that you are charged on a home loan. For this reason, it often makes more sense to use an offset account than a savings account.

Combining a Credit Card and Offset Account

One strategy that some people claim is helpful is to combine the benefits of an offset account with a credit card. If you pay all of your living expenses using a credit card each month, you will maximize the amount of money available in your offset account for the majority of the month. Each month, you can then use the offset account to pay off all of your credit card debt.

By using the credit card for your living expenses, all of your income and savings go toward reducing the interest on your home loan. This means that your regular payment will take a larger chunk out of your principle, meaning that you will be closer to paying off all of your debt on the home loan. Of course, the crucial part of this strategy is that you don’t go overboard with the credit card, and that you use it in such a way that allows you to pay it off each month.

Diverting Income to an Offset Account

By combining all of your accounts into one, an offset account gives you a bigger picture of what is going on with your financial situation. If you have investment properties as well as personal properties that you are lending through, an offset account allows you to divert all of your income through the offset account, reducing the interest that you have to pay on your home loan.

Turning Personal Property into Investment Property

It’s not uncommon for a borrower to buy a home for their own personal use with the expectation that they will eventually buy a better home and use the old one as an investment. Rather than selling the old home, they can rent it out and earn a passive income on the property.

One strategy that has proven very effective for some people would be to purchase the first property with an interest only loan linked to an offset account. Any extra payments they then made toward the loan could go into the offset account.

First of all, this would mean that the borrower would pay no extra interest on the loan. As long as they were able to make a payment equivalent to that of a standard loan, rather than that of an interest only loan, they would actually end up spending less in interest than they would with a standard loan. 

Later on, when the property became an investment, they would be able to enjoy some tax benefits. The principle of the loan would remain unchanged, and all of the interest charged would be tax deductible.

Not only that, but all of the funds that had been placed into the offset account could then be used in order to buy the next home.

In summary, the borrower has managed to take out an interest only loan without needing to pay any more interest than they would need to pay with a standard loan. They also manage to get the most out of their future tax deductibility when the property turns into an investment.

How to Determine if an Offset Account Will Save Money

One important thing to realize is that an offset account typically comes with a yearly fee. Before deciding to use an offset account, you need to be sure that it will save you more than the cost of this fee.

The first thing that you will need to determine is the average amount of money that will be in your bank account for the entire year.

In a situation where the interest rates are especially high, the amount of money that will need to be in your bank account if you want to break even will be lower.

To determine how much would need to be in your bank account, you would divide the cost of the annual fee by the interest rate. As an example, suppose that the annual fee was $400, and the interest rate were 10%. You would simply divide $400 by 10%, which gives you $4,000. This means that, on average, there would need to be $4,000 in your account each day.

This might mean that your account balance is near $8,000 for half of the month, and near $0 for the other half. You will need to take a look at your daily account balance over a period of a month to determine this exact value.

Of course, this only tells you if the interest savings are worth more than the annual fee. It doesn’t tell you if you would be better off placing the money elsewhere, such as in a saving’s account, or a different high yield investment. Only you can determine whether it makes more sense to use that $4,000 for something other than to offset your interest.

Learn more about mortgage offset accounts.