The Australian property market in cities such as Melbourne and Sydney has seen house prices rise dramatically in recent years. This means that when you are considering the best way to finance a house purchase, you need to make sure you are paying as little as possible.
For most people, this means finding the best interest rate and sticking to a long-term repayment plan. But for some people, there is a better option. An offset account can be set up to actually remove some interest. This works by leveraging early payment of the mortgage. For example, you may take out a 30-year mortgage, but set up an offset account that plans for paying the entire sum borrowed within 20 years. In this case, you can save potentially around 15% on interest payments. You will also build a comfortable cash buffer to give you some additional financial security until your home loan is paid off in full.
How Does an Offset Account Work?
An offset account is set up alongside a mortgage. The balance of the offset account is deducted from the principal remaining on the home load. For example, with a 100% offset account set up alongside a $150,000 mortgage, then interest is only charged on a total of $130,000. This, of course, reduces the overall amount of interest that is paid over the lifetime of the mortgage.
An Offset Account Does Not Affect Repayments
This is the part of the equation that is difficult to understand with regards to an offset account. The fact you have managed to lower the overall level of interest paid across the lifetime of the mortgage does not reduce monthly payments. Instead, it means that monthly repayments need to cover less of an interest charge, which results in more being paid off the original principle. This results in the mortgage being paid back earlier. So, think of it this way; an offset account doesn’t mean you have to pay less each month, but it does mean you have to pay for fewer months.
Leveraging Future Payments with an Offset Account
There is another major financial benefit of setting up and offset account. You can use overpayments to build up a cash reserve. The way this works is really quite simple. You would make the regular minimum payment on your mortgage each month. And then instead of paying a little extra to pay off your mortgage sooner, you pay it into your offset account instead. The offset account grows and will be used sometime in the future to pay off the mortgage sooner. But until it is, you can still use the cash held in the offset account for other things. So, if you hit some form of financial disaster, you can then use the cash held in the offset account to overcome it. If you had simply paid that money out as extra mortgage repayments, you would no longer have access to it.