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This popular mortgage strategy doesn’t always work
By John Collett
Mortgage offset accounts are promoted as one of the most effective ways to reduce interest costs, but they often have higher interest rates and the majority come with fees.
Money held in an offset account reduces the mortgage balance when calculating interest, saving on interest costs and shaving the time taken to repay the loan with the money easily withdrawn, if needed.
Offset accounts are promoted as a good way to reduce mortgage interest costs, but a reasonable amount has to be held in the account to make them worthwhile.Credit: Brook Mitchell
However, figures from comparison site Canstar show a decent-sized balance needs to be held in the account just to cover the higher interest rate, as well as any fees, before the offset account is worthwhile.
Lenders know many borrowers will tick the box on the loan application for the offset account without thinking through how much money they would realistically be able to maintain in the account.
Variable interest owner-occupier mortgages with offset accounts have an interest rate of 6.77 per cent, on average, compared to 6.5 per cent for mortgages without an offset account.
About two-thirds of offset accounts listed on the Canstar database have fees, with an average fee of $8 a month, or $96 a year.
The 0.27 percentage point higher interest rate for mortgages with an offset account equates to an additional $135 per month in repayments on a 25-year loan with a starting balance of $800,000.
Canstar calculates the extra 0.27 percentage points in interest and a monthly fee of $8 would require borrowers to maintain a balance of least $10,000 in their offset account, on average, throughout the 25-year life of the loan, just to break even.
On a starting mortgage size of $500,000, the offset balance would have to be at least $6500 over the 25-year life of the mortgage, assuming a fee of $8 a month.
The break-even point will likely be higher for those paying higher interest rates on their mortgages, such as those who have a mortgage with a big bank.
Lenders know many borrowers will tick the box on the loan application for the offset account without thinking through how much money they would realistically be able to maintain in the account.Credit: Louie Douvis
The break even point works at $22,000 for someone with a starting mortgage balance of $800,000 over 25 years, who is with a big bank.
On a starting mortgage of $500,000, the offset balance would have to be at least $14,300 over the 25-year life of big bank mortgage, just to break even.
Steve Mickenbecker, group executive of financial services at Canstar, says mortgage offset accounts can still be an effective way get ahead on the mortgage while parking savings that can be withdrawn if needed.
To maximise the benefit, however, mortgage holders would likely need to not only have their pay deposited straight into the account, but to build up the savings in the account as well, he says.
The lowest rate mortgages generally do not have the option of an offset account, with the sharpest interest rates of these below 5.75 per cent, more than 1 percentage point lower than the 6.77 per cent for those with offset accounts, Mickenbecker says.
Canstar’s database lists 37 owner-occupier, variable rate mortgages with interest rates below 5.75 per cent; though some of these are only available to borrowers who have more than 20 per cent equity.
Mickenbecker says there is an important benefit of offset accounts that cannot be captured in break even calculations.
The “effective” rate of interest on the money in the offset account is the mortgage interest rate which, for most people on variable rates, will be about 6.68 per cent, he says.
As the money in the offset account comes off the mortgage for the calculation of interest, but as no interest is actually paid, there is nothing to be declared to the Australian Taxation Office.
The interest paid on savings held in a term deposit or an online saver account, as well as paying less than the rate of the typical variable rate mortgage, would have to be declared in tax returns.
- Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.
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