What are Offset Accounts?
Understanding property finance 👉10
I firmly advocate the use of offset accounts linked to your mortgage. Essentially, it involves two components: the loan and an associated savings account known as an offset account. This account functions like any regular bank account, complete with an account number, debit card, and actual cash. Its purpose is to save you interest on the loan rather than accrue interest on the savings, essentially “offsetting” the interest.
Consider a scenario with a $400,000 loan at a 5% interest rate and $50,000 in the offset account. Instead of paying 5% interest on the entire $400,000 loan, you only pay interest on $350,000, saving 5% interest on the $50,000.
Now, let’s compare putting $50,000 in a savings account earning 3% interest versus placing it in an offset account. The savings account would technically yield only 2% after accounting for taxes, resulting in $1,000. In contrast, the offset account saves 5%, amounting to $2,500.
Using a money bucket metaphor, the savings account leaks 5% each month for the home loan interest charge, while the offset account doesn’t accumulate interest but prevents the leak, retaining the extra 5%.
Understanding this concept renders traditional savings accounts obsolete post-mortgage. Offset accounts are the way forward, as they offer numerous advantages:
Pros of Offset Accounts:
Reduces interest on the loan, regardless of whether the money is in the loan or offset.
Greater savings rate compared to a regular savings account.
Does not compromise the loan’s tax-related purpose, allowing flexible withdrawals.
Provides full access to funds at all times, recognised as your money.
Does not “pay down” the loan for tax purposes but achieves the same interest-saving effect.
Recognised as savings for assessment purposes when seeking additional loans.
Cons of Offset Accounts:
The temptation to spend readily available funds on non-essential items.
The Importance of a Cash Buffer:
Maintaining a cash buffer is crucial for unforeseen circumstances. An offset account serves as this buffer, acting as a safety net. I recommend having two offset accounts—one for personal finances and the other for property-related finances, each serving specific needs.
The ideal buffer amount varies, but a common guideline is three months’ worth of mortgage repayments. This buffer buys time, a valuable asset for property investors. It’s advisable to resist expanding your property portfolio until your buffer exceeds a certain threshold, ensuring financial security.
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