Home loan interest is the bane of every homeowner’s existence. It can make paying off your home loan seem like a distant and impossible dream, but there are ways to minimise the interest you are charged.
In this article, we’ll explain what an offset account is and how it can help you save on your home loan so that you can own your home sooner. And if you’re not interested in an offset account, we’ll tell you about other options to help cut years off your mortgage.
An offset account operates as a kind of savings or transaction account linked directly to your home loan balance. Its purpose is to reduce the interest charged on your home loan.
Let’s look at an example to explain how it works:
If you have a $400,000 home loan balance and $30,000 in your offset account, you’ll only be charged interest on $370,000. So, the $30,000 offsets the interest you are charged by your lender.
You can still access and use the money in your offset account on an everyday basis, but it’s smart to keep the balance of your offset account as high as possible to maximise interest savings. The more money that sits in your offset account, the less interest you’ll be charged on your home loan.
Remember that home loan interest is calculated daily, so your interest savings might not be linear if you’re regularly taking money out of your offset.
Let’s say you have a $30,000 offset for your $400,000 loan, but you need to pay a $2,000 bill. With interest being calculated daily, it will now be calculated on a balance of $372,000 ($400,000 minus $28,000).
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Since offset accounts are considered a loan feature, or an ‘extra’, lenders often charge a monthly or annual fee for them. The cost varies between lenders and may be something like $10 per month, $350 per year, or completely free.
Offset accounts are frequently bundled into home loan packages which may attract an overall fee that accounts for the offset account costs, loan maintenance and possibly other features.
Because offset accounts aren’t always free, it’s important to make sure that your offset account savings outweigh the fee you pay. If you’re not interested in using an offset account, check with your lender or read your home loan terms and conditions to ensure you’re not paying for one.
It would be a complete waste to pay for a feature you aren’t using!
Most homeowners use a full 100% offset account, which is where 100% of the offset account balance is deducted from the home loan principal when interest is calculated.
However, you can also have a partial offset account, where only a designated portion of the offset balance (typically 40%) is used to calculate interest against the principal of the loan.
It depends on what your priorities are. If you’d like to reduce your home loan balance, focus on making direct payments towards your mortgage.
However, if you’d like some financial flexibility, using an offset account means that you’ll be charged less interest while still having access to some extra cash.
For the undecided borrower, a redraw facility could be a solution to consider. Keep reading to find out what a redraw facility is and whether it could be a better fit for you.
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A redraw facility is a somewhat similar feature to an offset account in that it can help borrowers reduce their interest charges while having accessible cash on hand. Your redraw facility pools together any extra repayments you’ve made on your home loan which reduces your loan balance, and in turn the interest you are charged.
The benefit of a redraw facility is that you can ‘redraw’ your extra repayments if you need them. Unlike an offset account however, a redraw facility is not intended to serve as an everyday transactional account.
It’s best to limit redraws to larger expenses, like major bills or renovations. Lenders frequently charge a withdrawal fee for redraws and you won’t always receive your funds immediately.
So, if you’ve made $20,000 worth of additional repayments on your home loan, that’s $20,000 you’ll be able to dip into if you open a redraw facility.
For more information, read our comparison of the redraw facilities and offset accounts here.
The repayments you make on an interest only home loan won’t reduce the loan size at all - you simply pay for the interest accumulating on your loan.
While there may be strategic and tax benefits for property investors, interest only home loans can just delay the time it takes to pay off your home loan if you’re a regular borrower.
As obvious as it sounds, extra repayments will reduce your loan balance to help pay off your mortgage faster. Extra repayments don’t need to be made regularly, and can be done spontaneously if you receive a large sum of money that you don’t need for other purposes.
Be sure to check whether your lender allows you to make additional repayments, especially if you’re on a fixed interest rate.
Keep an eye out for more competitive interest rates because refinancing has the potential to save you thousands of dollars.
If you get a lower interest rate, your monthly repayment amount will reduce. However, consider increasing your repayment amount to match the amount it was pre-refinance. This will help you pay off your loan faster in a low-pressure way.
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Would you be open to paying larger monthly repayments if it means cutting years off your loan and thousands in interest?
If you can manage higher repayments, it’s worth considering if you’d like to own your home outright sooner. If you’ve had a pay rise, reduced debt or other changes in your financial situation, it might be a good idea to chat to a financial adviser or a mortgage broker about changing your home loan structure.
When considering increasing your repayment amount, also consider whether you’d be able to handle an interest rate increase.
If you make mortgage repayments fortnightly, instead of monthly, you’ll end up making an extra month’s payment per year. You’ll end up saving on interest because you’re paying off your loan faster.
Chat to your lender about amending your repayment schedule if you’re interested in this.
If you’re interested in an offset account, or would like to learn more about your home loan repayment options, get in touch with a Lendi Home Loan Specialist today.
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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.
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