HOW AN OFFSET ACCOUNT CAN HELP YOU PAY OFF YOUR HOME LOAN SOONER
Any homeowner’s ultimate goal is to basically pay off their home as quickly as possible, and to save on interest where they can. An offset account can certainly help with achieving these.
It’s really very simple and could save you thousands of dollars if you use it correctly. An offset account is a transaction or everyday banking account that is linked to your mortgage. Every dollar you have in that account ‘offsets’ the balance of your loan – reducing the amount of interest you pay every month. Because these savings add up over time, you can also use this ‘extra’ money to pay your loan off faster.
There are other ways to cut down how much you owe on your mortgage. Yet, the majority of tips all seem to focus on telling you to make extra payments and nothing else. What those kinds of tips don’t take into account is that many homeowners simply don’t have the extra cash to make large additional repayments. This is usually enough to make some people give up and believe they should just stick to making the minimum payments in order to stretch the budget further. Rather than think it’s not worth the effort, having an offset account can help you pay your mortgage off faster without breaking the bank.
Any opportunity you have to reduce the amount of interest you’re charged helps you to pay off your mortgage faster. If your home loan has the capacity to link an offset account to it, take advantage of this. Every dollar you leave in your offset savings account actively reduces the amount of interest you pay on your mortgage. For example, if your mortgage is $350,000 and you have $25,000 in your offset account you’ll only pay interest on $325,000.
The vast majority of mortgages have their repayments calculated to include a portion that covers the interest component and a portion that comes straight off your balance. If you can reduce the amount of interest you pay, this automatically means each payment you make pays more off your balance.
HOW TO USE AN OFFSET ACCOUNT CORRECTLY
Interest is calculated daily on your home loan and charged monthly. This means the more money you have in your offset account on a daily basis the more interest you will save. It may seem like a small amount on a daily basis, over the course of 30 years, the savings can be huge!
Make sure you have all your income going into your offset account.
You may also be eligible to have any rental income you receive go into your account to boost the amount of income and reduce the interest you pay (check with your accountant first).
Too really boost the effectiveness use a credit card for your monthly expenses. This will allow you to use the bank’s money through the month, and keep more of your income reducing interest on your home loan for longer. Although, this will only have a benefit provided the following:
1) The credit card has an interest free period – the normal is anywhere from 30 – 55 days interest free (using the bank’s money), and
2) The full balance of the card must be paid off before the interest free period expires otherwise you may end up paying more in interest than you save.
If you’re not convinced that it would make that much difference in the long term, consider this:
If you were to pay an extra $10 per week off your loan of $400,000 at 5% over 30 years, you would save $19,401 in interest over the term of your loan, and pay your loan off 1 year and 3 months sooner.
Effectively using an Offset Account exploits the principal of compound interest and can produce more dramatic results.
BENEFITS OF A MORTGAGE OFFSET ACCOUNT
By having a decent amount of money in your offset account, you can effectively cut years and thousands of dollars from your home loan. They also work just as well if you have your salary deposited into a standard savings account every payday – you don’t need a huge amount of spare savings. In this way, you can shave countless dollars and years from the life of your home loan.
DO MY REPAYMENTS GET SMALLER WITH AN OFFSET ACCOUNT?
No, your repayments will stay the same with an offset account.
What will change is the proportion of the amount of your repayment which goes towards the loan amount, and the amount that goes towards interest.
Because the offset account lowers the interest due on your loan, more of your repayment goes towards the actual loan amount, known as the ‘principal’.
AN EXAMPLE OF A MORTGAGE WITH AN OFFSET ACCOUNT
Now say you had a mortgage of $500,000 with an offset account attached. You could then store your $5,000 in savings within this offset account and only be charged interest on your mortgage less your savings, in this instance; $495,000 instead of $500,000.
You not only pay less interest, but you are not required to pay tax on the savings, meaning more money saved to benefit your overall financial position.
AN EXAMPLE OF A MORTGAGE WITHOUT AN OFFSET ACCOUNT
Imagine you have a mortgage of $500,000 and a high interest savings account with a balance of $5,000.
In this scenario, you are paying interest on $500,000 in debt while earning interest on $5,000 in savings.
The problem this creates is that you are paying interest to the bank, while earning very little interest on your savings (plus you will then be further taxed on the interest you have earned, making the net result rather pointless).
While savings accounts are useful for motivation, goal setting and just generally saving money; your money isn’t working as hard as it could if you do indeed have a mortgage with an outstanding balance.
For an honest and unbiased opinion, talk to Think and Grow Finance today on 03 8390 5855 or email mitesh@thinkandgrowfinance.com.au