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Home Loan Australia

Is an offset loan for you?

If you want to reduce the amount of interest you pay on your home loan, one option is an "offset" facility.

The way that this works is that, in addition to your home loan, you have a transaction account with the same financial institution. You deposit your income into the transaction account and use it for all your day to day expenses. Any money in this account is offset against the amount owing on your home loan and you only pay interest on the outstanding balance. So say, for example, that you have a home loan of $150,000 and you have a balance of $5,000 in your transaction account, you only pay interest on $145,000. Interest is calculated on a daily basis. It sounds like a great idea, a way that you can pay off your mortgage early and still have access to all your funds.

There’s no doubt that, providing you’re not paying any fee for the offset facility, its better to have than not have. The only problem is that, unless you can get access to all the features at a discount price (as you can under professional packages) offset accounts are only available at higher interest rates than loans without this feature. If you look at what that higher rate is costing you, then it usually turns out that on any sizeable loan you pay more for the higher interest rate on the bulk of your loan than you save on the slight reduction in the loan balance that the offset facility allows you.

I’ve attached a calculation I did for someone that compares two products, a basic variable rate product and a loan from one of the major banks. As the calculations show, in this person’s case the offset account reduced the loan balance by about $3,000 (actually this assumption was pretty generous to the offset account). That amounts to an interest saving of $178.50 per year. By contrast in the first year of the loan the simpler product would save nearly $1,000 in fees and charges leaving a healthy net saving of $818. This saving would rise over time if re-invested in the loan.

The other great advantage of an offset account is that you can pay your loan off faster than the repayment schedule demands when you want to and then get your money back later on. But there’s another way to do that - a redraw. If the offset is a Mercedes Benz, a redraw is a Holden Commodore.

Competition in banking has meant that, although ‘basic variable’ rate products used to be very inflexible, if you know where to look you can now have the most important flexibility features. The basic variable rate product which I mentioned to the client enabled him to pay his loan off as fast as he liked without penalty and it also enabled him to ‘redraw’ any excess he’d paid off from his loan.

It is more cumbersome than writing a cheque. It requires a fax to the bank and the payment of a small fee of between $0 and $50 depending on the amount redrawn and the institution. But it’s a perfect standby if the client wants to get his house painted, or add an extension to his house, or put a deposit down on another house sometime in the future. You can even write the cheque at the auction. And when you get home or back to work you can fax the money into your account! No-one knows you don’t have an offset account, except your lender and you.

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