A lot of us have them, but do we know how they work, what they’re for and when they’re useful?

I’m talking about offset accounts. Often offered by your bank, or talked about at BBQs, but not always fully understood. So, this week we’ll get every question you ever had about offsets cleared up once and for all!

What is an offset?

An offset is a bank account that is linked to a home loan or an investment property loan. It works like a regular bank account, but any money you have in that account is “offset” against your loan balance reducing the interest you pay.

 So how does it work exactly…?

Say you have a $300,000 home loan and $25,000 in savings. Rather than being charged interest on the full $300,000, and earning interest on the $25,000 (which you then pay tax on), if you put the savings in an offset account you will  not earn any interest on your savings, and instead will only be charged interest on $275,000 on your mortgage. That’s your total loan, minus the amount in your offset. The interest you are paying is reduced based on the amount in your offset account.

How much could I save with an offset?

It depends on how much is in your offset – the higher the offset balance, the bigger the saving. Using the example above, if your loan is $300,000 over 30 years at 5% interest and you had $25k in your offset for the life of the loan, you could shave a whopping 3 years, 9 months off your loan, and save a total of $73,320.14 in interest!

Does an offset change my repayments?

Generally your repayments stay the same but what changes is the proportion that is paid as interest and the proportion that goes towards paying off your actual loan amount (“principal”). Because the offset account lowers the interest you need to pay, more of your repayment goes towards the loan.

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What is the difference between offset and redraw?

An offset account keeps your money separate to your home loan, but still allows you to benefit by reducing your interest.

A redraw facility lets you to deposit any spare money directly into your home loan account and you can then “redraw” any funds that are in excess of your regular repayments.

Perhaps most importantly, there can be tax implications if you put money on your loan, “redraw” it and then say, turn your home into an investment property in the future. Less of the interest on the loan could be tax deductible (depending on what the redrawn funds were used for). So for this reason an offset is often the recommended method of saving on interest.

In addition if you put the money into your mortgage there can be redraw fees and limits to how much you can redraw at a time – these would not apply if the money was sitting in the offset account instead.

Who is an offset for?

Offset accounts are generally useful for people who have a good balance in their offset and can maintain or increase that balance over time. They aren’t for everyone, so its always useful to see your accountant or financial adviser to talk about the best option for you.

Does it cost money to get one?

It can. Fees associated with a home loan that has an offset could be slightly higher (often ranging anywhere from $60-$400 a year), or you might pay a higher interest rate.

This post was originally published by Women With Cents and was republished here with full permission. For more financial wisdom, check out her website and Facebook page.