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.
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* 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