An offset account is a type of bank account that is linked to a loan (typically a mortgage) account, with the aim of reducing the amount of interest that the borrower has to pay.
Here’s how it works: The balance in the offset account is ‘offset’ against the loan balance for the purpose of calculating interest. For instance, if you have a mortgage loan of $200,000 and $20,000 in an offset account, you only pay interest on the net difference, which is $180,000. The offset account balance reduces the effective loan balance for interest calculation, but it doesn’t reduce the principal loan balance itself.
Offset accounts are typically checking accounts, allowing depositors to use them just like any other bank account for everyday transactions. They can deposit their salary into it, set up direct debits, use a debit card linked to it, and so on.
One of the main advantages of an offset account is potential interest savings over the life of a loan, which could also result in a shorter loan term. This can be a great feature for home buyers or other borrowers looking to reduce the overall cost of a loan.
However, loans with offset accounts can sometimes come with higher interest rates or fees, so it’s important to weigh the benefits against the costs. As always, the suitability of financial products depends on individual circumstances, so borrowers should consider seeking advice from a financial adviser.
Example of an Offset Account
Imagine you have a mortgage loan of $300,000 at an annual interest rate of 3%. Without an offset account, your interest for the year would be $9,000 ($300,000 x 3%).
Now, let’s say you have an offset account linked to your mortgage loan, and you maintain an average balance of $50,000 in it over the course of the year.
In this scenario, the interest on your loan is calculated not on the full $300,000, but on the net balance after offsetting the $50,000 from your offset account. That means you’re paying interest on $250,000 ($300,000 – $50,000), not the full loan amount.
At a 3% interest rate, the interest for the year on $250,000 would be $7,500.
So, by having $50,000 in your offset account, you’ve effectively saved $1,500 in interest payments ($9,000 – $7,500) for the year.
It’s important to note that the savings can be significant over the life of the loan, and if those saved amounts are left to offset the loan balance, it could also potentially shorten the loan term.
Keep in mind, though, that this is a simplified example. Actual savings would depend on several factors, including the interest rate, loan balance, offset account balance, loan terms, and more. Also, not all loans come with an offset account feature, and some might charge higher rates or fees for this benefit.