Home Mortgages How To Use An Offset Account to Pay Off Your Mortgage Faster

How To Use An Offset Account to Pay Off Your Mortgage Faster

written by Shelley Marsh 10/09/2013
How to Use An Offset Account

For those who missed part one of this series on how to pay off your mortgage faster, please click here.

Ok, now on to the second part of how to pay off your mortgage faster, and this week it is all about how to use an offset account.  Many of you probably have one of these accounts as part of your home loan package, but it never ceases to amaze me how many people don’t really understand how it all works.  Most of the time I think it is because the banks don’t want to explain it to you properly because it is not in their best interests for you to pay off your mortgage early.  They would prefer to charge you the fees for the facility and not have you use it!  So here is my attempt to explain it all fully.

First of all, I have to declare this is one of my most favourite strategies to pay off a mortgage and it is the one my husband and I have used to banish ours.  But be warned, it is not for everybody.  Using an offset account is a strategy that requires oodles of financial discipline.  If this is not you don’t be concerned, just make regular repayments off your mortgage as outlined in part 1.  Easy.  However, if you have solid financial discipline then an offset account can be a great way to turbo-charge your repayment strategy.

So what is an offset account?

An offset account is a transaction account that is linked to your mortgage. The positive balance of your account is offset daily against the money you owe on your home loan.  This reduces the amount of interest you have to pay on your home loan.  For example, if your loan is $400,000 and you have $100,000 in savings, using an offset account will mean you only pay interest on the outstanding home loan balance of $300,000  ($400,000 loan minus the $100,000 savings).  This can cut years off your home loan term.  And remember your savings don’t have to be that big.  Keeping a balance of even $3,000 in the offset will make a difference in the long term.

Ok, so the aim of the game when you use an offset account is to keep as much money as you can in the account to reduce the interest charged on your loan.  This is where the financial discipline comes in.  You see the catch with an offset account is that it is like a normal bank account.  You have access to the money all day, everyday.  So if you can’t handle the temptation to spend, do not use an offset account!!

As the aim of the game is to keep your offset account balance as high as possible it is a great idea to have all your income paid into the account.  Wages, dividends, tax refunds, the lot.  Also, to take the strategy to a new level, many people then use their credit card to pay for their expenses.  This means that your income hits the offset account straight away and reduces your interest bill.  But by using your credit card it means that your costs for the month do not get paid for until the end of the interest free period.  Therefore, keeping the balance on your offset account as high as possible for as long as possible.  The key to using your credit card in this strategy is that you MUST pay off the balance EVERY SINGLE month.  Which is easily organised using an automatic debit through internet banking.  If you cannot pay off your credit card every single month, do not even think of using this part of the strategy as paying 20% interest on your credit card does not make sense to offset a mortgage which is only charging 5% interest.

Other tips for using an offset account:

(1)    Make sure it is a 100% offset account to make sure you are getting the full interest offset on any money you keep in the account.  That is if your interest rate on your home loan is 5% then the money in your offset account will offset the full 5% interest.

(2)    Make sure you link the offset account to your home loan.  Believe it or not you can have an offset but if you do not link it to your mortgage it will not be offsetting anything, regardless of how high your balance is.  Friends of mine had $100,000 in their offset account, only to find that they were being charged full interest on their mortgage because the two accounts were not linked!!!  &*^^%% (insert appropriate swear word here) banks!

(3)    Check how much the fees you are being charged for your offset account are and make sure it is worth it, given your guesstimate of your running balance in the account.

(4)    Offset accounts often come with a higher interest rate to pay for the flexibility.  Check the how much extra interest you might have to pay and make sure it is worth it.

(5)    Using an offset account can be seen as more tax effective than keeping your savings in a bank account.  This is because if you have a savings account with 4% interest and say you are getting charged 37% tax this is equivalent to roughly a 2.5% after tax return.  With the offset you get the benefit of offsetting 5% interest without any tax as you are not earning any interest, as such.  It is the equivalent of a 5% return tax-free.

Using an offset account can be a brilliant strategy to reduce your home loan.  Just be very sure you have the financial discipline to pull it off.  As without financial discipline, this strategy could send you backwards fast.

If you would like to read more from me in 2015 don’t forget to sign up to my weekly email using the form below:



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Happy Investing!

 

Money Mummy

* Please note this is for your general information only and does not constitute financial advice.  Please see a financial planner or accountant to get advice specific to your individual needs

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55 comments

Alison at The Thrifty Issue 10/09/2013 at 12:19 pm

I don’t know why I haven’t done this earlier! Yes, I do. We have been with ING Direct for our home loan which didn’t offer an offset account. But I saw something earlier this year and I think they have one now. I’ll use next week’s time off work to investigate further and finally take some action! Thanks for the tips once again Money Mummy 🙂 Cheers, Alison

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Shelley Marsh 11/09/2013 at 6:25 am

Hi Alison, no worries! It definitely warrants further investigation. As my wonderful “thrifty” friend and I am sure you will be all over the costs involved and whether it adds up for your family. Money Mummy.

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Aroha @ Colours of Sunset 10/09/2013 at 12:20 pm

Hmmm, I don’t have a mortgage, but I was hoping one day I’d win the lottery and be able to buy lots of houses, have minimum mortgages and be winning all round. Is there a way to make that happen?! 😉 Great tips for home owners – I def believe in paying off your mortgage as quick as possible! -Aroha (#teamIBOT)

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Shelley Marsh 10/09/2013 at 4:07 pm

Hi Aroha! 🙂 Good luck with the lotto! My hubby has that gig covered in our household. I tell him the probabilities but he doesn’t listen 🙂 Money Mummy

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Lani 10/09/2013 at 3:11 pm

My hubby is all down with the offset account! It is a great idea and I’m sure has saved us heaps already 🙂

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Shelley Marsh 10/09/2013 at 4:08 pm

Hi Lani! Well done to your hubby! I am sure he has saved heaps. Money Mummy

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Brish Wilson 10/09/2013 at 9:59 pm

Hi Shelley, I have the ability to simply make extra payments into my mortgage (and have the freedom to withdraw those extra funds out, that’s where that financial discipline comes into play!!) I assume this is just as equally financially beneficial as the offset account system?

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Shelley Marsh 11/09/2013 at 6:36 am

Hi Brish, yes the make extra repayments and then withdraw as required is basically the same as using an offset account. The only difference is that you won’t have the benefit of offsetting your income every month and using the credit card strategy. This is only a marginal benefit every month but might add up over time. Making extra repayments then having the ability to withdraw is a brilliant strategy and will certainly get the job done. So, if it is working for you stick with it because it is essentially the same. I try to never fix what ain’t broken! Money Mummy p.s if you have a big savings account balance then that is when an offset can make a big difference, but in your case you would just put it into the loan.

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Mamagoingsolo 11/09/2013 at 9:02 pm

Wow another thing I had never heard of! Thanks to you I am now paying my mortgage weekly instead of monthly and am trying to put lump sums extra in wherever possible. Next: see about this offset account!

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Shelley Marsh 11/09/2013 at 9:29 pm

Yes, an offset account is worth thinking about. Just make sure the costs don’t outweigh the interest saved. Good luck! Money Mummy

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EssentiallyJess 12/09/2013 at 3:19 pm

Yep Boatman is often talking about offset accounts to people, even though we don’t own a home. In fact he talks about it so much, if he doesn’t bring it up now, I do, pretending I’m some kind of expert 😉

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Shelley Marsh 13/09/2013 at 2:12 pm

Go Jess! Thanks for hosting IBOT every Tuesday it is great! Money Mummy

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Jasmine | indiemama.com.au 13/09/2013 at 3:22 pm

We love offset accounts. We learned the hard way that it isn’t always the best strategy to pay down your loan balance as quickly as possible. And that extra repayments are possibly better put into an offset account.

For us, we thought it made sense to put all our savings towards an extended round the world trip on to our home loan, then redraw the funds when we were ready to go. We were going to rent out the house while away, then live in it when we got back until we could find our ‘forever’ home and turn the first property into a rental.

Well, the ATO gave us a rude shock when we found out that when we took out the extra repayments, the higher loan balance was considered ‘new borrowings’ and we couldn’t claim the interest on tax. It wasn’t a huge amount of money but the principle was important to learn. Now, we make extra repayments into an offset account to retain the full tax advantage of the interest costs, just in case we ever need to move out and rent the house out in the future.

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Shelley Marsh 14/09/2013 at 10:10 am

Hi Jasmine, yes that must have been quite a shock! The ATO know how to get you, don’t they! Yes, what you experienced is another reason to use an offset account especially if you are thinking you might turn your home into an investment property at some point in time. I hope you enjoyed your overseas trip. What an awesome opportunity! Thanks for sharing your story. Money Mummy

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Mandy 13/09/2013 at 10:25 pm

Wise wise words. Love it.

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Shelley Marsh 14/09/2013 at 10:10 am

Hi Mandy, I am glad you liked it! Money Mummy

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Kushla 06/10/2013 at 8:56 pm

Just wondering if you know if you can get your mortgage repayment to come out of your offset account, cause if you put all your earnings into the offset where do they draw the mortgage from?

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Shelley Marsh 06/10/2013 at 10:35 pm

Hi Kushla, we use an offset account and we set it up so all our repayments come directly from the offset account via direct debit. Thanks Money Mummy

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Brae 29/10/2013 at 7:17 am

I have an offset account linked to the mortgage. I pump everything into the offset account and the wife wants to pay off the mortgage. I want to leave everything in the offset but she wants to move into the mortgage. Should we be leaving in the offset or taking money out and putting it into the mortgage? Once you have put the money in the mortgage can you get it back if you need the money?

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Shelley Marsh 30/10/2013 at 10:15 pm

Hi Brae, which way is best for you depends on your individual circumstances and how your loan in particular is set up. Maybe you could talk to your lender and find out exactly how your loan works and then ask them for the difference between the two strategies in your particular case or see a mortgage broker or financial planner for advice suitable to your individual needs.

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Andrew G 27/11/2013 at 5:51 pm

Hello Money Mum, I would your opinion on my situation. My wife and I have recently bought our first house, We have an offset account which is working for us well at the moment. lets say we owe $300,000 on my mortgage and combined we earn $1500 after tax per week. If were to pay $1000 per week into my home loan rather than leaving it in my offset then over time wouldn’t it benefit me more because i would be paying the principal as well? I am all new to this and when we got approved the lady at the bank suggested the offset account which we went for but i just look at the debt and have always paid off debt as fast as I can. Is there something I’m missing? I have a redraw facility on my account if that helps. cheers

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Shelley Marsh 29/11/2013 at 9:53 pm

Hi Andrew, I would ring up your bank/loan provider and ask them the difference in your specific case, as home loans can be structured slightly differently. I love your fast approach to debt repayment – looks like you are well on the way to owning your own home outright. Well done.

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Nic 17/01/2014 at 8:10 pm

Hi Money Mum,

You said the offset account is like a normal transaction account, can set up direct debit for mortgage repayments. Can you also freely transfer funds ie to pay off the credit card balance, “Pay Anyone” etc?

Thanks for your help!

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Shelley Marsh 20/01/2014 at 1:03 pm

Hi, our offset account is just like a normal account (actually we converted our previous transaction account over to an offset) we use it for paying bills, ATM withdrawals, credit card payments all the normal things. Just ask your bank to confirm that if you got an offset account it would work the same. Thanks Shelley

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Kirk Stephen 18/01/2014 at 5:31 am

In regards to point 2. That is almost definitely a bank error and I would suggest your friends complain and try and get the interest savings credited back by their bank. I’m speaking from experience as I got ANZ to do this with mine. Although I noticed after less than a week after drawing the mortgage, so it was only a few dollars.

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Shelley Marsh 20/01/2014 at 12:55 pm

Hi Kirk, yes you are right – if this happens the banks should credit the difference. Thanks for the tip!

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Mel 16/08/2014 at 1:55 pm

What about if the home loan is interest only? My mum wants me to either convert my loan to P&I or to pay my lump sum off the principal, but my mortgage broker continues to tell me the offset and credit card strategy is best. When does this strategy stop being effective and when does the principal start to go down? My mum inks never!

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Shelley Marsh 16/08/2014 at 7:59 pm

Hi Mel – if you have an interest only loan, then the principal never goes down if you stick to the set repayment. That is you if borrow $300,000 interest only then at the end of the 30 years you have only paid interest and you still owe the bank $300,000. So in this scenario, to pay off principal you could do a lump sum repayments or put money in the offset and leave it there, which is like paying off principal, but the principal balance is still there. Or like you said you could move to a principal and interest loan. Which strategy is right for you is entirely dependent on you and your individual circumstances. I hope this makes sense.

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Karen 08/10/2014 at 11:44 pm

This is a really great strategy for reducing your mortgage! I’m interested to know why Mels broker set her up interest only? Makes sense if its a rental and maybe thinks any lump sums should be used as down payment for another? Either way, the strategy is the same. Your mother is both right and not quite right – it really depends on how disciplined you are (as Shelly points ou)

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Shelley Marsh 12/10/2014 at 7:04 am

Hi Karen, yes I think using an offset account is a really great way to reduce your mortgage as long as you are disciplined. Not sure why the broker took Mel down the interest only path. Putting on my super suspicious hat – mortgage brokers do get paid a trail commission the longer your mortgage is out so maybe that might be behind the advice? Other than that I do not know.

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mel 21/01/2015 at 6:31 pm

Hi,

We have a 100% offset account with our mortgage I put all my money in for the week (excluding petrol and my pocket money, I withdrawl that the night I’m paid) I then pay all of our bills and the food shopping out of the offset. Hubby likes to just put in his mortgage payment into the offset and pay bils as he goes. He can’t get his head around knowing what is mortgage money, what is bill money and what is spending money. Do you have any tips or tricks on how to make this easier to understand? TIA

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Shelley Marsh 22/01/2015 at 7:40 am

Hi Mel, yes that is the problem with offsets is that the money is all in one lump sum. I have heard some lenders will give multiple offsets against one mortgage so maybe ask your lender. Otherwise I have had friends who have run spreadsheets so each time they get paid they split the money out into different amounts on the spreadsheet in separate columns so they know how much they have set aside for their rego, groceries etc. I hope this helps thanks Shelley

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A Loren 06/03/2015 at 9:23 pm

Thanks for the insightful article! Very helpful and lucid.

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Shelley Marsh 08/03/2015 at 8:37 pm

Thanks! I am glad you liked it!

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Dan 04/04/2015 at 8:34 am

Can I put my savings in my brothers offset account? Is there a limit to how much i can put in?

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Shelley Marsh 06/04/2015 at 8:20 pm

Hi Dan – interesting question – as far as I know there is no rule against it but if I was you I would seek financial advice from a financial planner to understand the full implications of doing this.

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Ana 09/05/2015 at 8:09 pm

Hi Shelley,
Have you posted a calculation showing how o retire on investment properties? People usually say we should buy around 6 properties now that we are on our 40’s so we by our 60’s we could sell 4 to full pay 2.
Is there a website were we can check how to calculate that? I mean, taking in consideration the growth of the house valuation, rent expected, expenses with the purchase and afterward with annual fees, maintenance, accounting, tax return (using offset account), etc…
Thank you, Shelley.

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Shelley Marsh 12/05/2015 at 8:10 am

Hi Ana, sorry investment properties are not my thing. I am not sure if there are any calculators out there. Be careful there are lots of property spruikers out there who will sell you over priced properties with over priced finance so be careful and make sure you get good independent individual financial advice from a planner or accountant if you are looking at this strategy.

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Michael 10/08/2015 at 12:05 pm

Hi Shelley,

What happens when I fill up my offset? So say if I have a mortgage of $200,000 and I fill my offset account to $200,000, is there any benefit to paying off my mortgage faster if I continue to build the offset account over the $200,000, or should I put the extra money somewhere else where it can work better for me?

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Shelley Marsh 11/09/2015 at 4:54 pm

Hi Michael, I am not sure what would happen ask you lender they should be able to help you. I would assume offsetting more than your mortgage would be of no benefit, but it pays to ask what would happen. Thanks Shelley

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eddie 14/03/2016 at 11:00 pm

Hi,

Great write up! My apartment will be finished in the end of this year. Offset account is what I need! Just one question, my partner and I are considering getting a new car (borrowing $60,000 roughly). Can I link my offset account to both home and car loan? Or, including them into a single loan?

Or just link the offset account to home loan, as its benefit the most. And just pay the car loan separably.

Cheers

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