Does a 100% mortgage offset account match your needs?
Savvy borrowers, just like this week’s competitors in the Australian Open, have an endgame in sight before they even start their first match. Furthermore, just like a tennis player mates the right tools (racket, strings, outfit) to their strategy, a borrower needs to evaluate their loan functionality and check whether it is going to help them win financially.
Borrowers usually focus on the here and now, not the distant future. Rather than the size of their loan balance in 10 or 20 years, many borrowers are more likely to think about how much they can borrow and the kind of house they can afford. Smart borrowers, however, know that strategy matters. The years roll around and it’s always better to pay off a mortgage before its term and, as a consequence, pay less interest to the bank.
The good news is that if a mortgage offset account is right for a borrower, it can help them do just that. The bad news is that 100% mortgage offset accounts are regularly spruiked by banks trying to meet quotas for new account openings and shady companies pedalling ‘rapid mortgage reduction strategies’. Even ASIC has issued guidance via its Moneysmart website: “Be wary of companies that offer loans that claim to pay off your mortgage faster. The only way you can do this is by increasing your repayments or finding a loan that has low fees and a low interest rate.“
So, let’s look at what a mortgage offset account is and why someone may or may not need one.
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A mortgage account with 100 per cent offset is a fully featured transaction account that sits alongside a home loan. In many ways it acts just like a regular bank account.
However, along with the usual facilities, like ATM access and direct debit, there’s another significant advantage: Any money sitting in the offset account reduces the amount that the bank calculates interest payments against.
That’s right. The loan principal is reduced for the purposes of interest calculation by the amount of money in the offset account, without increasing the repayment amount.
An example may make it easier to understand how an offset account works. If a homebuyer has a principal sum of $350,000 outstanding on their mortgage and also has $10,000 in a linked 100 per cent offset account, the bank will only charge them interest on $340,000.
The money they save in interest goes straight into paying down their loan principal, which has the effect of reducing the interest paid over the life of the loan, as well as the overall loan term. Less money paid off faster.
When borrowers realise that banks calculate interest on mortgages daily, offset accounts can be used proactively. For example, getting salary paid into an offset account means the loan principal is in effect reduced by that amount as soon as it is paid.
Savvy borrowers may even choose to use interest-free days on their credit cards to pay for goods and services, so they can keep cash in their offset accounts working for them.
Unfortunately it is not that simple. Some important factors to consider when evaluating a loan with such functionality include:
- Whether you are paying a price a premium on the loan interest rate for the functionality?
- What transactional fees and charges are likely to be encountered when operating the offset or loan account?
- Whether there are annual or monthly fees and what service costs are covered by such fees?
- Whether you can deposit your salary directly into the offset?
- Whether you require flexibility on the size of your repayment – which may mean that a line of credit is more appropriate?
- Whether you need such functionality because of specific strategic objectives, for example, in using the 100% offset account as a part of a tax minimisation strategy (as advised by a licenced taxation adviser).
This is not an exhaustive list, but these key factors in addition to others, should add up to make a significant difference to the cost/benefit relationship of such functionality. It is worth noting that for many people who do not have the aim of turning their PPOR into an investment property and/or people with smaller incomes and savings balances, that a basic variable loan with fee-free redraw and direct salary crediting may suffice.
Credit advisers help borrowers apply for and secure appropriate home loans every day. They will usually compare a range of competitive products, and look at loan features like offset accounts so borrowers can make informed decisions.
It’s important to know that offset accounts are usually included as part of fully featured home loans, which might mean you pay more in fees or a higher interest rate. So discussing your financial circumstances with a credit adviser could be a smart first step.
Game, offset, match
In any sport, a match isn’t won instantly. Points are accumulated over time. Borrowers who are serious about winning the mortgage game need to be aware that having a mortgage offset account does not automatically guarantee them an edge in the long term. However, when appropriate to the borrower’s circumstances, with the points scored daily by an offset account, it can be game, offset and match.