I was speaking with a Doctor the other day that was struggling to make the decision on how to prioritise their finances. On one hand, they want to pay off their mortgage quicker, and on the other, they want to save money for holidays and retirement.
When you have a large loan like a mortgage, the main thing that people usually think about is how fast can it be paid off. Most of them go about speeding up their repayments, paying more than the minimum requirement, but there is another option. Using an offset account to reduce the time and money spent paying off the loan.
An offset account is a savings or transaction account that is linked to your home loan with the goal of saving you money on interest.
It works by reducing your mortgage’s interest by the same amount of money that is saved in the account. For example, if you have a $350,000 home loan balance and you have $25,000 saved in your offset account, you only have to pay interest on $325,000 of that balance.
There are two types of accounts that are commonly used for mortgages, partial and 100%.
A 100% account is considered the most effective type as 100% of the balance in the account is applied to the loan, reducing the amount of interest you have to pay. Partial accounts are still useful but are less beneficial when paying off loans quickly, as only the interest earnt from the account goes towards reducing the amount of payable interest on the loan.
Using an offset account can help you save thousands of dollars over the life of your loan, but there are a few things that you can do to help you save more. Here are our top 4 ways to use your offset account to save money on your mortgage.
Directly depositing into your offset account to build interest.
Your offset account has a higher interest rate than your regular savings account, this interest is usually compounded on a more regular basis than a normal savings account, and that interest is compounded daily, you can earn more.
Connecting your debit account to your offset account, effectively turning it into your daily transactional account, then having your salary deposited directly into it can help you earn more even if the balance fluctuates.
Using your offset account to pay off credit cards
If you are dedicated to saving money and are focused on building the amount of money in your account, the less likely you are to spend that money. To help build your savings, you can strategically defer expenses daily expenses to a credit card which has a decent interest free repayment period on purchases. When you make your monthly mortgage, repayment, you fully pay off your credit debt at the same time. This gives you more time to build interest and clears your credit debt for the month.
Make your savings work harder by putting them directly into your offset account
Most people have a separate savings account that they use to put money away for holidays, emergencies, etc., however, if you were using a high-interest savings account, the interest earned from that account would be automatically be classed as an earning and taxed. Offset accounts, however, aren’t subject to tax meaning that you could save more and pay less on your loan.
As a safety buffer
If something bad happens that changes your income drastically such as sickness, injury, unemployment, etc., or you need to make a large one-off payment to cover an emergency, the money you have saved in your offset account can be used to cover it. Using your account like a safety net is a good way to ensure that you are covered if something goes wrong and your situation changes, while still paying off your mortgage at the same time.
In March of 2017, Australian Prudential Regulation Authority (APRA), the governing body responsible for overseeing the finance industry, found that 37% of all loans had some form of offset account attached to them, a 2% rise from the year before.
The use of offset accounts is on the rise in Australia, if you would like to know more about them and how having one could help you pay off your mortgage, contact your local mortgage broker.