What is an offset account?
An offset account usually comes with a professional package product with a lender and is generally only available with deposit taking institutions (main stream banks).Offset accounts are generally designed to be a transactional account, meaning funds flow in and out of the account regularly (as opposed to a typical redraw facility).
Some institutions allow multiple offset accounts and generally they can only be linked to a variable loan. Most fixed rate loans do not permit the use of an offset account.The way an offset account works is as follows:
- Loan balance is $100,000
- Offset account balance is $10,000
- Interest is calculated based on the balance $90,000 as opposed to the full $100,000
- 4% interest on $100,000 is $4,000 per year or $333 per month.
- 4% interest on $90,000 is $3,600 per year or $300 per month.
- Therefore with the offset account having $10,000 balance, you could save $400 per year.
By placing money in your offset account, your basically earning the interest rate on your offset account balance (e.g. 4%) as opposed to the very insignificant standard savings account interest rate of ~1-2%. What’s better is that you don’t get taxed on this interest savings as you normally would if it was earned as income through a savings account.In addition to this, each future principal and interest repayment made will reduce the loan term, simply because more of the repayment is contributed towards the principal as opposed to the interest component. For example, if your minimum principal and interest repayment is $1,000 per month and the normal interest component is $300, by using the offset account, the interest component is less and therefore the principal amount will be higher (i.e. more than $700) for the month.