Owning a home is a significant expense. In fact, for most Australians, buying a home is the biggest purchase they will ever make.
Most of the money that you pay during the initial years of the loan are applied to interest. While this will eventually change, it can be frustrating to watch most of your repayment get applied to interest.
Offset accounts provide a way to reduce your interest. However, setting up an offset account may not always be the best solution for every homeowner in Australia.
Before setting up an offset account, you should know how these accounts work and who they are intended for.
The Basics of an Offset Account
Offset accounts are becoming more popular in Australia, as they provide a way to reduce interest payments. The offset account is a savings or transaction account that is linked to your home loan.
Many home buyers do not understand how interest is calculated. Instead of calculating the interest each month or quarter, lenders calculate interest daily. The amount of interest charged is based on the remaining principal on the home loan.
With an offset account, lenders subtract the balance of the offset account from the principal before calculating interest. The offset account offsets the value used to calculate interest.
Who Should Consider Using an Offset Account?
Anyone who can regularly deposit funds into the offset account can benefit from this solution. Families with multiple incomes, significant disposable income, or high monthly expenses may benefit most from the offset account.
For best results, you need to maintain a significant balance in your offset account. For example, if you have $150,000 remaining on your home loan for the next ten years and set up an offset account with just $1,000, you will only save about $10 per month on your repayments. Using the same example, if you increase your offset account to $10,000, you could save $100 per month.
Who Should Avoid Setting Up an Offset Account?
Applying for an offset account may be a smart solution for reducing your interest payments. However, there are a few situations where you may want to think twice about setting up this account. There are as host of articles on the RBA website about offset accounts.
If you cannot afford to deposit a significant amount of money in the offset account, the benefits will be minimal. To reduce the interest with an offset account, you need to maintain a positive balance in that account. This may be difficult for those with less income.
Lenders also often charge an annual fee for the offset account. The average fee is about $400 per year, which may limit the advantages of this option for those with limited funds.
Last Thoughts on Setting Up an Offset Account
The bottom line is that an offset account can provide a great way to reduce interest payments. However, these accounts can still be confusing to understand. To learn more about how these accounts work, you should take the time to research the basics of offset accounts.