How an offset account reduces home loan interest
An offset account is a transaction or savings account linked to a home loan. The Reserve Bank of Australia describes it as operating like an at-call deposit account, with the balance netted against the outstanding loan when interest is calculated. Lenders generally perform that calculation daily. A borrower with a hypothetical loan of $500,000 and $50,000 in a full offset account is charged interest on $450,000. At an illustrative rate of 6.00% per annum, the interest avoided is approximately $3,000 in the first year.
The account itself pays no interest. The benefit is received as a lower interest charge on the loan, while the scheduled repayment stays the same. Because less of each repayment is required to meet interest, more is applied to principal, and the loan is repaid ahead of schedule. Every dollar in the account contributes for each day it remains there, which is why many borrowers have their salary credited to the offset account and meet expenses from it progressively. The funds remain available for withdrawal at any time, in the same way as an ordinary deposit.
How the offset account calculator works
The calculator first determines the principal and interest repayment for the loan balance, rate and remaining term entered. It then simulates the loan month by month in two ways. In the first, interest is charged on the whole balance. In the second, interest is charged on the balance less the average offset balance, and the repayment is left unchanged. Since the repayment is constant, the interest saved each month reduces principal, and the second loan reaches a nil balance sooner. The differences in total interest and in the number of months are reported as the interest saved and the reduction in loan term.
The first-year saving is a simpler figure: the offset balance multiplied by the annual interest rate. It is an approximation, and it is the most useful number for comparing the benefit with an annual fee. Two assumptions should be kept in mind. The offset balance is treated as constant for the life of the loan, and the interest rate is assumed not to change. In practice balances rise and fall and variable rates move, so the long-term figures indicate the scale of the benefit and are not a prediction.
Choosing the average offset balance and other inputs
The average offset balance is the input that requires the most judgement. Interest is calculated daily, so the relevant figure is the typical balance across the whole month, and not the balance on the day after salary is received. A borrower whose account rises to $30,000 on pay day and falls to $20,000 before the next has an average of approximately $25,000. Reviewing the closing balance on several dates across two or three months of statements gives a reasonable estimate. Where a partial offset applies, only the stated percentage of the balance should be entered.
The loan balance, interest rate and remaining term should be taken from a current loan statement. Because the constant balance assumption is demanding, it is prudent to run the calculation with a conservative figure that the borrower is confident of maintaining, and again with a higher figure that reflects expected savings growth. The gap between the two results indicates how sensitive the benefit is to saving behaviour. Testing a rate one or two percentage points higher is also informative, since the value of an offset balance rises and falls with interest rates.
Illustrative example: $10,000, $50,000 and $100,000 in offset
Consider a hypothetical loan of $500,000 at an illustrative constant rate of 6.00% per annum with 30 years remaining, for which the repayment is approximately $2,998 per month. An average offset balance of $10,000 saves approximately $600 in the first year. If that balance were maintained for the life of the loan with repayments unchanged, the calculator estimates total interest saved of approximately $47,500 and a loan term shortened by 1 year and 3 months.
A constant balance of $50,000 on the same loan saves approximately $3,000 in the first year and approximately $194,600 over the life of the loan, which would be repaid 5 years and 4 months early. A balance of $100,000 saves approximately $6,000 in the first year and approximately $318,000 in total, with the term shortened by 8 years and 10 months. The lifetime figures are large relative to the first-year saving because the interest saved each month is applied to principal and compounds over decades. They depend entirely on the balance being held throughout, which is the reason a conservative average is recommended.
Whether an offset account is worth the fee
Offset accounts are commonly attached to package loans that carry an annual fee, or to products priced slightly above a basic loan without the feature. A break-even balance may be estimated by dividing the additional annual cost by the interest rate. On hypothetical figures, an annual package fee of $395 and a loan rate of 6.00% give a break-even balance of approximately $6,600. Below that average balance the fee exceeds the interest saved, and above it the account produces a net benefit.
A rate premium should be treated in the same manner. If the loan with an offset account were priced 0.10 percentage points above a basic alternative, the additional interest on a $500,000 balance would be approximately $500 per year. Combined with the $395 fee, the annual cost would be $895, and the break-even average balance would rise to approximately $14,900. The first-year saving reported by the calculator may be compared directly with a figure of this kind. Borrowers with modest savings may find that a basic loan with free redraw provides a similar benefit at lower cost.
Offset account compared with a redraw facility
The Reserve Bank has observed that, for a household with a mortgage, a deposit into an offset account and a prepayment available for redraw have a similar economic effect, because each reduces net debt and the interest payable. The interest saving on an equal amount is therefore the same. The differences are legal and practical. Money in an offset account is a deposit belonging to the account holder and is accessible by card, transfer or withdrawal. Money available for redraw has been paid into the loan and has reduced the debt.
Access to redraw depends on the terms of the loan contract. Lenders may impose minimum redraw amounts or fees, may take a day or more to release funds, and in some contracts retain a discretion to reduce or withdraw the facility, particularly as the loan amortises. For borrowers who rely on the money as an emergency reserve, that distinction may matter. On the other hand, the reduced accessibility of redraw may suit borrowers who prefer that the funds are not available for everyday spending. The BorrowWise extra repayments calculator models the redraw approach.
Tax treatment: savings accounts and investment loans
Interest saved through an offset account is not income, so no tax is payable on the benefit. Interest earned in a savings account is assessable income. As a hypothetical comparison, a savings account paying 5.00% per annum to an account holder with a marginal tax rate of 32%, including the Medicare levy, returns 3.40% after tax. On $50,000 that is $1,700 per year, compared with approximately $3,000 of interest avoided on a loan charged at 6.00%. The outcome depends on the respective rates and the tax position of the individual.
The distinction between offset and redraw is significant where a property is, or may become, an investment. Withdrawing money from an offset account does not alter the loan balance or the purpose for which the loan was borrowed. A redraw is generally treated as a new borrowing, and where redrawn funds are applied to a private purpose the interest attributable to that portion is generally not deductible. Owner-occupiers who may later rent out their home often prefer to accumulate savings in an offset account for that reason. The rules are detailed, and a registered tax agent can advise on individual circumstances.
How Australian lenders structure offset accounts
Offset accounts are predominantly a feature of variable rate loans. A Reserve Bank review of fixed rate lending published in March 2023 noted that most fixed rate products do not include an offset facility, and that borrowers with split loans are able to use offset and redraw on the variable portion. Some lenders do provide an offset on fixed loans, in certain cases as a partial offset under which only a percentage of the balance reduces interest. The calculator assumes a full offset.
Other points of difference include the number of offset accounts that may be linked to one loan, which is useful for households that separate funds for bills, tax or holidays, and whether a minimum balance applies before the offset takes effect. Offset balances above the loan balance provide no further benefit, and the calculator limits the first-year saving accordingly. On an interest-only loan, which the calculator does not model, the saving is received as a lower repayment and not as a shorter term. The BorrowWise guide to fixed and variable rates discusses split loans further.
Common mistakes and acting on the result
Frequent errors include entering the peak balance instead of the average, paying for a package when the typical balance is below the break-even level, and assuming that a partial offset operates as a full one. Another is holding substantial savings in a separate account at a lower after-tax return while the offset account remains nearly empty. Borrowers who use a credit card for daily spending in order to keep cash in the offset account for longer obtain a small additional benefit, but only where the card is repaid in full before interest is charged.
To act on the result, the first-year saving may be compared with the annual cost of the feature, including any rate premium. Where the saving is comfortably higher, consolidating savings and salary into the offset account maximises the benefit. Where it is lower, a basic loan with redraw may be more economical, and the BorrowWise refinance calculator may be used to test the alternative rate. Repayments should be left unchanged so that the interest saved reduces principal. These results are general information only and do not take personal objectives or circumstances into account.
Offset Account Calculator: frequently asked questions
How does an offset account work on a home loan?
An offset account is a deposit account linked to a home loan. Interest is calculated each day on the loan balance less the balance of the account, so any amount held there, including salary awaiting use, reduces the interest charged. The scheduled repayment does not change, so the interest saved is applied to principal and the loan is repaid sooner.
How much interest does an offset account save?
The annual saving is approximately the average offset balance multiplied by the loan interest rate. As a hypothetical illustration, $50,000 held against a loan charged at 6.00% per annum saves approximately $3,000 in the first year. If the balance were maintained for the life of a $500,000 loan over 30 years, the calculator estimates total interest saved of approximately $194,600.
Is an offset account worth it?
It depends on the average balance and the additional cost. Dividing the annual fee and any rate premium by the interest rate gives a break-even balance. On hypothetical figures, a $395 annual fee and a 6.00% rate produce a break-even balance of approximately $6,600. Borrowers who expect to hold considerably more than the break-even amount may benefit, while others may be better served by a basic loan.
What is the difference between an offset account and redraw?
Both reduce interest by the same amount for an equal sum. Funds in an offset account are deposits that remain separate from the loan and are available at call. Funds available for redraw are repayments already applied to the loan, and access depends on the terms of the lender. The two may also be treated differently for tax purposes where the loan relates to an investment property.
Is an offset account better than a savings account?
For many borrowers it may be. The benefit of an offset account is equivalent to earning the home loan rate on the balance, and the benefit is not taxed, whereas interest on a savings account is assessable income. The comparison depends on the two rates, the marginal tax rate of the account holder and any fee or rate premium charged for the offset facility.
Can an offset account be linked to a fixed rate home loan?
Offset accounts are generally a feature of variable rate loans, and most fixed rate products do not include one. Some lenders offer an offset on fixed loans, in certain cases as a partial offset that counts only a percentage of the balance. A split loan, with the variable portion linked to the offset account, is a common alternative.
Does an offset account reduce the monthly repayment?
On a principal and interest loan it generally does not. The scheduled repayment remains the same, and because less interest is charged, a larger share of each repayment reduces principal, which shortens the loan. On an interest-only loan the repayment is the interest charged, so an offset balance does reduce the amount payable each month.
How much should be kept in an offset account?
There is no prescribed amount. Any balance reduces interest, and the benefit grows in proportion to the amount held and the time it remains in the account. Many borrowers hold their emergency reserve and day-to-day funds there. As a minimum test, the average balance should exceed the break-even level at which the interest saved equals the additional annual cost of the feature.
Sources for the offset guide
- Reserve Bank of Australia: Offset account balances and housing credit (Statement on Monetary Policy, August 2015, Box E)
- Reserve Bank of Australia: Fixed-rate housing loans, monetary policy transmission and financial stability risks (Bulletin, March 2023)
- Reserve Bank of Australia: Households' mortgage prepayment buffers (Financial Stability Review, September 2012, Box B)
- Reserve Bank of Australia: Lenders' interest rates