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Arrange a free, no obligation discussion with a mortgage professional online or by calling 1300 55 81 61, or read on to learn about the different types and advantages of different offset facilities.

Before reading this Offset Accounts vs Redraw vs All in one, you should read our Offset tutorial to ensure you have an understanding of how offset works.

Fact:

If you don’t make extra repayments (payments above the minimum repayments) and you don’t have offset features, you will take the full term of your mortgage to pay it off. Used properly, these interest saving features can save you thousands in interest and wipe years of debt from your mortgage.

Whilst it is true that offset facilities and extra repayments can have a dramatic effect on the amount of interest you pay and the time it takes to repay your mortgage, be wary of any person suggesting that you will repay your mortgage in 15 years or less without increasing your repayments by at least 30%.

The three main offset features available on mortgages in Australia are extra payments/redraw; offset accounts and all-in-ones. If you don’t want to spend the next 30 years repaying your mortgage, you must take a moment to understand each of these features and develop and implement a solution that works for you.

Extra repayments and redraw only

Most variable home loans allow you to make extra repayments and redraw (the ability to withdraw your extra repayments if you need to). This is the most basic interest saving feature available. Money is deposited into your mortgage either by salary crediting or by transferring money from a bank account. To redraw, the reverse is done and you transfer money from your mortgage to your bank account, usually via internet or telephone banking.

Advantages:

The main advantage is the clumsiness associated with this type of facility.

You cannot access your extra repayments quickly or directly. The temptation of withdrawing money via ATM or EFTPOS doesn’t exist as you can’t do it. Even if your bank account and mortgage are with the same institution, redraw usually requires internet or telephone access to transfer the money, although some require a faxed confirmation from you as well!

Once you initiate a redraw, the money stops offsetting your mortgage interest and enters limbo for up to 48 hours before it arrives in the account where you can access it. Consequently, you are discouraged from redrawing extra repayments on a regular basis and these funds are left where they are probably doing the most good – reducing the interest you pay and the time taken to repay your mortgage.

Disadvantage

The main disadvantage is the clumsiness associated with this type of facility.

Even in the most streamlined redraw arrangement can result in funds in limbo each time you deposit or redraw. Time spent in limbo = money that you haven’t saved in interest. Worse still, the challenges in accessing redraw can discourage you from depositing as much money as possible and moderates the funds that offset your mortgage.

Beware of

• Mortgages requiring a fax notification to activate redraw
• Redraw fees
• Limits and conditions on redraws
• Mortgages that do not allow direct salary crediting
• Lenders claiming this type of facility to be the same as an offset account or all-in-one
• Myths that claim offset accounts are a more expensive option
• Lenders not offering their own bank accounts to simplify transfers

Mortgage offset accounts

Mortgage offset accounts are every day banking accounts offered by your lender, which are separate to your actual loan account, but linked for the purposes of calculating the daily interest. A good mortgage offset account eliminates the need for you to have separate bank accounts, which reduces the cost to you in time and fees in managing these accounts.

Generally speaking, your mortgage offset account should be accessible via internet, telephone banking, EFTPOS and ATM. Some also offer cheque book and branch access. Which is the most important to you comes down to what suits you and how you see yourself using this account. A good mortgage offset account allows you to direct credit your salary, auto debit mortgage and credit card payments and bPay your bills.

Advantages

For most people, an offset account replaces the need for any other bank account, which simplifies management and reduces fees you would pay elsewhere in your budget. The main advantage is that every cent in your offset account is working to reduce the interest and time taken to pay off your mortgage. Every day, 24 hours a day.

A strategy by smart borrowers is to use their offset account as the main transaction account and arrange regular lump sums to be transferred from the offset or direct salary credited to their mortgage, which then acts as a savings account, as the extra money is out of sight, but not completely out of reach in case of emergency. Using this approach, both savings and money readily available in the offset account offset mortgage interest.

Disadvantages

There is a perception that you have to pay extra for an offset account, however when you compare similar quality lenders and mortgage products, this is untrue. Some basic variables offer 100% offset at no extra cost. If you are borrowing more than $250,000, packaging often results in the inclusion of an offset account and interest rates for full featured mortgages around or below those of reputable basic variables.

Beware of

• Limitations on accessing your offset account
• ATM and EFTPOS fees – although some lenders even waive foreign ATM costs
• Comparing a basic loan and forgetting regular banking costs that will be replaced by the offset account
• Lenders not offering offset accounts ‘educating’ you about offset accounts

All in one mortgages

All in one home loans are mortgages that also operate as everyday banking accounts. The two most common forms of these types of facilities are either Loan Transaction Accounts or Lines of Credit. Of these two, a line of credit is normally the most flexible and accessible, however there are some dangers and additional costs that may be associated with this type of mortgage. You should not take one out without first reading the line of credit tutorial.

The second type of all-in-one less commonly available is a Loan Transaction Account (LTA). This type of mortgage is a hybrid between an offset account and a mortgage where your loan account actually becomes your primary banking account.

Important: At least one major lender has limitations on their offset account that may render it ineffective. You may be recommended a split loan with a small line of credit to overcome these limitations when dealing with this lender or lenders like them. In these cases, keep your line of credit split as small as possible. It should be no more than $20,000 unless you have specific reasons for a higher limit.

Advantages

Like a mortgage offset account, an all-in-one replaces the need for any other bank account.

Disadvantages

The main disadvantage to an all-in-one mortgage is the combination of transactions, savings and debt into a single account can make it very difficult to budget or easily monitor the effectiveness of this strategy or your ability to save. Unlike a mortgage offset account, you cannot quarantine savings into your mortgage.

Lines of credit also have their own risks and many people who take out a line of credit for all of their borrowings do not make any progress on repaying their mortgage at all, let alone faster.

Loan transaction accounts may also have limitations that prevent scheduled payments and transfers and similar transactions that are more readily available from offset accounts.

Beware of

• Access fees
• Free transaction limits (such as 5 per month etc)
• Restrictions on bill payment and transfer scheduling
• Debt reduction salespeople who suggest repayment of your mortgage in 15 years or less
• All-in-ones being passed off as being the same as or better than mortgage offset accounts

Related mortgage topics. See also :

• Interest Only
• Line of credit
• Mortgage resources and Learning Centre

Offset is how repayments, extra payments and other interest reducer features affect the interest calculation and overall cost of your mortgage. Contrary to popular belief, offset is not a feature, but a characteristic of a loan. Although offset is a little complex to understand, it is a crucial characteristic if you wish to accelerate your mortgage and repay in less time with less money.

Most mortgage lenders calculate interest on daily balances, but only charge it monthly. This means if you change the balance of your loan on any day by making an extra payment, the interest calculated for that day will be lower than the lender predicted when they estimated your minimum repayments. This reduction in the interest calculation is called ‘offset’ because the extra money has ‘offset’ the loan balance for the purpose of interest calculation. Most lenders, although not all will pass the savings from this interest reduction on to you.

Offset becomes relevant if your mortgage is an all in one or offers interest saving features such as accepting extra payments or other interest saving facilities such as ‘offset accounts’. When used properly, these features will reduce the interest you will pay and the time it takes to repay your home loan.

How offset shortens your mortgage

Although offset will reduce the interest you pay on both principal and interest mortgages and interest only mortgages, offset will usually only shorten the length of your mortgage if you are already paying principal and interest. This is how it works.

When you take out a mortgage, your lender calculates a Minimum Repayment that you are required to make as a part of your loan contract. Your Minimum Repayments are based on four key variables.

1. Loan Balance
2. How often you will make repayments (also called repayment frequency)
3. Interest rate
4. Your specified loan term

Each of these factors is called an assumption as the lender assumes a value to enable them to calculate your Minimum Repayment. From these assumptions each Minimum Repayment has an assumed principal component and an assumed interest component. The interest component is based on your interest rate and assumed daily Loan Balances. So each Minimum Repayment will be made up of two parts and is best thought of as:

Minimum Repayment = Interest + Some Principal

Where Interest is the charge the lender makes for lending you the money and Some Principal is an amount of money that goes towards reducing the amount of money that you owe (your Loan Balance).

If your actual Loan Balance is less than the assumed Loan Balance when your Minimum Repayment was calculated, then the amount of interest due will also be less however your Minimum Repayment will remain the same. As a result, the part of the your Minimum Repayment that was assumed as, but not charged as Interest goes towards Some Principal and reduces your Loan Balance. This then creates a reduced Loan Balance for all subsequent Interest calculations and the savings begin to snowball. What starts out as a modest saving builds up speed an power over time.

Small, regular deposits can wipe years off your mortgage and save you tens of thousands in interest.

Offset – the nett of tax advantage

For personal borrowers, using your savings to offset the balances of your mortgage is far more effective than having those same funds deposited in even a high interest savings account. The reason for this is two fold.

The first and most obvious reason is the rate of interest you are charged on your mortgage is usually higher than the rate of interests earned from banks and other most ’safe and accessible’ savings accounts. As an example, if the interest charged on your mortgage is say 9%, you will probably earn around 7% for funds in a high interest savings account. As a result, your gross advantage of having money offsetting your mortgage would be around 2% over interest earned from the savings account. ie. money offsetting your mortgage means you are not paying 9% rather than earning 7% from a high interest savings account.

The second, and sometimes less obvious benefit is that income earned is taxed, whereas expenses you avoid, are not. Most people, need to read that sentence twice, so here it is again. Income earned is taxed, whereas expenses you avoid, are not.

This means that if your savings earn interest of 7%, you will be required to pay tax on those savings. If your marginal tax rate is say 30%, you will be required to pay tax of 30% x 7%, or 2.1%. This means your nett of tax advantage for those invested savings is 7% – 2.1% or 4.9%.

Compare this to saving 9% in mortgage interest for having those funds in offset instead which results in you avoiding an expense of 9%. Your nett of tax advantage is 9% in offset versus earning 4.9% interest, which is a substantial difference.

However the nett of tax advantage only applies if the borrowings are for personal use. Investment borrowings do not get the same advantage because the interest on investment debt is tax deductible. So whilst you will get a slightly better return because you avoid paying a higher rate than you would otherwise earn, there is no real tax saving.

Partial Offset

Partial offset is an offset feature where only a portion of your extra funds offset interest calculation for that day. For example, a partial offset of 40% will only offset interest calculations by $4,000 when you have extra funds of $10,000 in your offset facility or mortgage. Although this type of feature is most common amongst fixed rate loans, some lenders sneak it into their variable rate loans as well. If you want to get the most from your offset facilities, make sure they are 100% offset, regardless of which type offset feature you choose.

Different types of offset features

Different mortgages have a range of features that are often clustered together by lenders as ‘offset’, however these features operate differently and can result in starkly different outcomes.
If you are interested in interest offset options you should also read
the offset account vs redraw vs all-in-one tutorial.

Extra payments and redraw

Available on most loans and commonly passed off by sneaky lenders as ‘offset’ to beef up the appeal of their ‘cheap’ mortgage. Money can be deposited into the loan from another account and when redrawn, must be transferred to another account to access those funds.

Offset account

An offset account is an account that is separate to your mortgage that you can use for everyday banking like depositing your pay, growing your savings and paying your bills. Although the offset account is separate to your mortgage with separate statements, access and balances, the daily credit balance of the account offset the debit balance of your mortgage for the purpose of calculating interest.

All-in-one

There are a couple of different types of all-in-one mortgages available, however the offset and access benefits are a combination of the extra payment/redraw feature and the offset account feature. Your every day banking is done directly from
your home loan. Be careful of the ‘cheap’ version of these loans as lenders will promote the mortgage as ‘fee free’, but then charge you each time you access deposits. Small regular charges can really add up.

Beware of

Mortgages that do not allow additional payments. If a mortgage does not allow additional payments, you will have no choice to pay it off over the full term. If mortgage allows extra repayments, check that offset applies and it commences on the day you make your extra payment.

You should also beware of Lenders who describe offset as a special feature of a mortgage as all good quality mortgages offset additional payments. The term ‘offset’ is often used by lenders to describe different mortgage features in an attempt to make inferior products sound better and the benefits and disadvantages are fully explained in the features section mortgage tutorials which you can find here.

Related mortgage topics. See also :

• Offset account vs redraw vs all-in-one
• Mortgage resources and Learning Centre