Mortgage Offset Accounts: How Do They Work?

Co-author: Nicole Barratt

What is an offset account?

An offset account is a transaction account that is linked to your home loan. The account’s balance (or a proportion of that balance) is offset daily against your home loan balance. As a result, you’re only charged interest on the difference between the total loan balance and the amount offset.

This means the lender charges you less interest, because they’re not charging interest on the full balance of your outstanding loan. Offset accounts are more commonly linked to a variable rate home loan. 

How does an offset account work?

Offset accounts work by using up to 100% of the balance of a linked transaction account, or accounts, to offset or effectively reduce the portion of your home loan that is accruing interest.

For example, if you have a loan with a balance of $350,000, with $50,000 in a linked 100% offset account, you only pay interest on $300,000 of your balance.

Types of offset accounts

There are two main types of offset accounts:

1. 100% offset account: this offsets the interest payable on the mortgage by the full balance of the account.
2. Partial offset account: this only offsets your mortgage by a portion of the offset account balance. This means the higher the percentage of the offset account, the more you will save in interest on your mortgage. For example, if you have a loan of $350,000 with $50,000 in a linked 50% offset account, you would only pay interest on $325,000 of your balance. Partial offset accounts are not very common here in New Zealand.

What are the pros and cons of an offset account?

Pros:

• Pay less interest on your home loan. By having money in your offset account, you can cut years from your home loan and pay thousands less in interest. You don’t necessarily need a huge amount of spare savings, either. If you have a 100% offset account, every cent in your account saves interest off your loan.
• Get your savings to work harder for you. Your home loan interest rate will typically be higher than the interest rate you earn on a savings account. Therefore, your savings can work harder for you in an offset account, compared to a regular savings account. 
• Keep extra funds at hand. An offset account can be an easy way to keep excess funds at hand, while still minimising interest payments on your mortgage. If your financial situation changes, or if something unexpected, like a medical emergency happens, you can easily access the money offsetting your mortgage.

Cons

• Potential for higher fees. You may find yourself paying an additional fee for a loan with an offset account.
• Potential for higher interest rate. You could end up paying a higher interest rate on your mortgage, as floating rates are generally higher than fixed rates.

The financial benefits of a mortgage offset account will depend on a number of factors, such as the interest rate and fees of comparable loans (with or without an offset facility) and how much money you keep in your account. It’s important to weigh up your individual circumstances to determine if an offset account is right for you.

Does an offset account reduce monthly repayments?

When you have an offset account, your monthly repayments typically stay the same, even though you may be charged less in interest.

This affords you the opportunity to repay your loan faster. As the offset account helps reduce the amount of interest being added to your loan, more money goes towards paying off the principal (your loan amount).

How can I use an offset account?

The more money you put into an offset account, the more interest you will typically save on your loan. To help maximise the balance of your offset account, one option is to get your salary deposited directly into your offset account and then use the account as an everyday transaction account.

Because your home loan is offset on a daily basis, the longer you keep your money in an offset account, the more interest you can save.

If you have a credit card and are disciplined with your spending and repayments (i.e. you repay the card balance in full each month), then another option some lenders suggest is to use your credit card to pay for your everyday expenses.

The theory is this could help you keep money in your offset account for longer, thus saving more interest on your home loan. However, this approach can be quite risky and may not be suited to everyone. 

For example, you need to make sure you repay your credit card in full and on time each month. Also, you need to avoid unnecessary spending that could make the repayments less manageable.

Such spending could also lead to you building up debt that would incur interest or fees that would likely outweigh any savings made through your offset account.

It also helps to factor in any other credit card fees, too, such as the annual fee, before deciding if this approach is suitable.

How can I choose an offset account?

When choosing a home loan with an offset account, consider features such as:

• An account where 100% of your total balance is offset against your loan
• No minimum balance, so every cent in your offset account is working for your loan
• No maximum balance limit, so you can keep growing your savings and paying less in interest on your home loan
• Low or no fees on the offset account
• The ability to use your offset account for the transaction types you need, such as debit card, ATMs, eftpos, direct debit and in-branch
• The ability to link multiple accounts as offset accounts to your loan

It’s also important to consider the home loan interest rate carefully. In reality, particularly early in your loan term, your home loan balance is likely to be significantly larger than your offset balance, so having a competitively priced home loan could make a significant difference, too.

Saving up a larger deposit for your home may also save you considerable money during the lifetime of your loan.

What’s the difference between an offset account and a redraw facility?

Offset accounts and redraw facilities are both common home loan features. However, there are some differences and it’s important to consider which would work best for you.

A redraw facility is a feature available on some floating-rate loans. It allows you to withdraw money that you’ve already contributed to your home loan. The balance of the redraw facility is whatever extra payments you have made towards repaying your loan.

When choosing between an offset or redraw facility, you must decide what is more useful for you:

• Reduce the interest on your loan while maintaining day-to-day access of your cash:

A mortgage offset account offsets the interest owing on your account and you still have daily access to the money. This will suit someone who wants to minimise the interest they owe on their repayments.

• Pay off the loan principal itself:

By paying the money directly into the loan, a redraw facility allows you to make payments towards paying off the principal balance of your loan, rather than simply reducing the interest you pay. This will suit someone who wants to pay off their mortgage sooner.

Whichever type of facility you use, any extra money that you can pay onto your mortgage can save you significant money in the long term in interest savings. Consider too:

• Money sitting in an offset account generally remains accessible whenever you need it. With a redraw facility, you need to make an application to withdraw money, so it isn’t always instantly accessible. There may also be minimum and maximum redraw amounts.
• An offset account can hold any spare savings you have. A redraw facility is only available for any additional repayments you have made above and beyond your usual monthly repayments. You can only redraw the extra you’ve already paid.
• Offset accounts may have low or no account-keeping fees and some transaction fees. Fees may apply when using redraw facilities in some situations.
• As it’s easier to access money in an offset account, it’s also easier to spend it. So a redraw facility may be more suitable if you find it hard to resist impulse spending.

What are some other ways I can save money on my home loan?

Being mortgage-savvy can potentially save you tens of thousands of dollars over the life of your home loan, depending on the loan size and savings techniques used.

Here are some ideas that could be worth weighing up that may help improve your home loan saving strategy:

1. Secure a lower interest rate. Do some research to get an idea of what interest rates are available for home loans with the features you’re looking for. Then consider negotiating a lower interest rate with your current lender or refinancing. Also, check you’re not paying too much in fees.
2. Keep your repayments the same. If you get a lower rate, maintaining your monthly repayments at their previous level will help you repay your loan faster, and save money on interest over the life of your loan.
3. Increase your regular payments. Making an effort to put some extra spare cash towards your mortgage (additional repayments) each month can help you repay your loan faster. You might like to try Canstar’s extra home loan repayments calculator to see how much you could save.

You can also check out our range of other Home Loan calculators to help you get a better understanding of your financial situation. Not only can you compare mortgage rates for free on our site, we publish expert research into the best lenders in the market. To read why Kiwibank took out our award for Bank of the Year | Home Loans 2020 click this link. Or to compare current mortgage rates, click on the big button below.