An offset mortgage is where a savings account is set up/linked alongside your mortgage account. Whilst no interest is paid to the savings/offset account, the amount in your offset account is deducted from the balance of your home loan when calculating the interest payable on your home loan portion. Provided you’re disciplined with your finances, an offset mortgage can help you save money in the long run.
Offset mortgages taking advantage of the fact that you get less interest on your savings than the interest you pay on your home loan.
For example, an offset mortgage with a $200,000 balance and $10,000 in the savings/offset account would only charge interest on the $190,000 portion. There are tax advantages too – particularly for higher rate taxpayers, as you don’t pay any tax on the reduced interest you pay. So, rather than receiving, say, 5% on your savings, ending up with 2.7% after tax for top rate taxpayers or 4.1% for 30% taxpayers, you can get the equivalent of 8% on your mortgage.
A 10-year mortgage at 8% would accrue $88,597 in interest. By using that $20,000 to offset the loan (and effectively make it $180,000) you would accrue $53,072 in interest, a whopping $35,525 less. So although a top rate taxpayer would have sacrificed $6,042 in interest on their savings, they would have saved nearly six times as much on their home loan.
Offset mortgages can be particularly useful if you’re self-employed. Using an offset account for money set aside for tax bills is an excellent way of getting the taxman’s money to work for you.
Don’t let this added flexibility confuse the issue of the rate you’re paying. Calculate what you expect to save and work out how much extra you may be paying compared to a basic variable rate mortgage
Offset mortgages are clearly a good option for anyone with a hefty amount sitting in cash. However, don’t get carried away, this should be a feature, not the be all and end all. Unfortunately, many home loan providers charge you at a higher rate than their other products for the pleasure of having an offset facility available.
As a rule of thumb, to make a real difference you need around $10k in savings for every $100k mortgage debt. However, smaller amounts can make a real difference, too.
• The balance held in your offset account reduces the balance on which interest is chargeable in the offset account
• In effect, you receive a rate of interest on your savings equivalent to the rate you’re paying on your home loan.
• The savings you make on the interest is tax free.
• You may have higher monthly fees attached to the account.
• You may need to maintain a minimum balance in the offset/savings account.
• Interest rates charged may be higher than available on Honeymoon Rate and Basic Variable Rate mortgages.