Better late than never for Barclays-ABSA merger
1 January, 2013Smart Investor: Earning It, February 2013
1 February, 2013Smart Investor, February 2013
When you’re repaying a mortgage, there’s often cash floating around in a savings account which could help you pay it down a little quicker. But perhaps you’re not sure if you’ll need the money for other things, so are unwilling to commit the funds to the mortgage.
The idea of an offset account is that it helps to put more of your money to work to reduce interest payable on a home or investment loan, but without actually using that money to make repayments.
An offset account is basically just a bank deposit account, but one linked to a loan, whether for your home or investments. The way it works is that the balance of your account is offset every day against your outstanding loan balance. Doing so reduces the interest payments on your home loan, and ultimately the term and the total you repay.
ANZ uses the following example. A customer with a $150,000 home loan on a 30-year term would pay about $167,190 in interest (this is based on a standard variable rate of 6.6% a year; naturally the figures vary with interest rates). If this person had an offset account linked to the home loan throughout, with a constant balance of $10,000 in it, the effect would be quite dramatic. The loan would be paid off in 26 years and 4 months; and the total interest bill would fall to $127,553.
That’s a saving of three years and eight months, and $38,636.95 in interest.
NAB makes its calculations slightly differently, picturing a $320,000 home loan, a 25-year term, a 7.22% rate and a constant level of $10,000 sitting in the everyday banking account. In this instance, the saving would be one year and 8 months, and $46,319.
Why these savings? Well, in the NAB example, because of that 10k in the bank, your interest is being calculated on a $310,000 balance instead of $320,000. In the ANZ example, interest is charged on $140,000 instead of $150,000. Over a long period of time, the consequent interest savings really mount up.
Now, most people don’t normally have a constant balance of 10 grand sitting in the bank doing nothing, but you get the picture. There is a clear benefit in putting savings to work in reducing interest payments, even if you don’t then use those savings to repay the principal.
One area some people get confused is whether they are allowed to withdraw funds from their offset accounts, and whether there is any tax liability involved in doing so. The thing to remember is that these funds are simple, and basically just deposit accounts: your money doesn’t need to be earmarked for additional repayments, or for anything else. Drawing funds from an offset account is just the same as withdrawing from any other savings account. There’s no penalty involved, and no tax implications either.
So is there a catch? Yes, there is. Offset accounts don’t generally earn any interest. And, since Australia is one of the few countries in the developed world where you can still earn money from doing nothing but leaving money sitting in the bank, that is worth considering. However, if your home interest rate is higher than your savings account interest rate – and unless you opt for a fixed rate mortgage at the perfect time before the Reserve Bank of Australia pushes rates up dramatically, that’s almost always going to be the case – then you’re better off with an offset. This is particularly true because you usually pay tax on any interest you earn in a savings account.
BOX: Choosing the right account.
A great many providers offer offset accounts. So how to compare them?
- Check whether there is a minimum balance required in order for the offset balance to apply.
- Check how frequently the interest on your home loan is calculated, and also how frequently your offset balance will be checked in that calculation.
- Check if there are phone and internet fees for transferring money from one account to the other, and if there is a fee to set this up in the first place.
- And check the percentage of your account that will be considered an offset against the home loan – plenty of providers offer 100% offset, so there’s no reason to opt for less.
- Finally, and most obviously, what’s the rate on your loan? It might be handy if they offer you an offset facility, but it won’t compensate for them charging you a high rate on the home loan.
