I can already hear you all cry out in response to the title…
But they let you offset the balance of your loan saving you thousands in interest!
Well I’m afraid there’s a better way to get your cake and eat it too.
What is an offset account?
First off, let’s have a quick overview of what an offset account is for those of you who don’t know. As a quick example, say you have $10,000 in savings and a $400,000 loan @ 7%. You don’t want to put that $10,000 into your mortgage (for some reason) but want to “keep it around”. So instead, you get an offset account.
What the bank will gleefully tell you is that by paying more money to them, they’ll offset the interest of your loan by that $10,000. You’ll still have access to the $10,000 when ever you want, but the interest on your loan will be calculated on $400,000 – $10,000 = $390,000. So you basically save $10,000 * 7% = $700 per year in “offset interest”. Magical huh!? How could this NOT be good??
Why it’s all a load of shit.
Offset accounts cost you money. They cost you money by having a higher interest rate or they might even charge you a yearly fee (or both!). Now the bank will no doubt do magical calculations (as above) and go “Look! Even though we’re charging you $800 a year for this offset account, you’re going to save more due to paying less interest!” and they’re right. I’m a big fan of math and calculations and they are almost always right. However here’s the thing… you can get the benefits of an offset account without paying their stupid fees!
Getting your cake and eating it too
To get the benefit of paying less interest simply make an extra repayment on your mortgage with that $10,000. Now many people will assume that once it’s in your mortgage… you can never touch it again! But they’re wrong. It’s called “Redraw”, where you make a redraw on your mortgage. This just simply means you’re taking money back OUT of your mortage (instead of paying it off). Most mortgages these days have a $0 redraw fee which means… it costs you nothing to get that $10,000 back!
Simply ensure that your mortgage has a $0 redraw facility (note some may have a minimum withdrawal of say $1,000), stop paying for the “premium” loans that give you an offset account and plow all your extra cash into the mortgage. Maybe keep $2,000 or so in cash for bills and so on but everything else you can put into the mortgage. If there is ever a very major emergency that would require you to all of a sudden need $10,000, simply redraw that amount out of your loan. Within a day or two it’s in your account and you can get your cake and eat it too.
Does it really matter?
Lets take a top four bank example, the Commonwealth Bank. At that link (at the time of writting this post) you have a few choices. One is their “No Fee Variable Rate” loan that has a rate of 6.5%, it has no offset account but a $0 redraw cost option. Another option that has an offset account is their “Standard Variable Rate” loan with a rate of 7.01%.
Even if we’re generous and say that you pay your $400,000 loan off in 15 years with fortnightly repayments… the difference that rate costs you (which really we can consider to be the cost of having an offset account) is an extra 0.51% worth of interest which = $20,326.62
Is waiting two or so days any time there’s a major emergency and you need that $10,000 really worth $20,326.62 over 15 years? That’s $1,355.11 a year! Now yes, their “Standard Variable Rate” does include some other benefits along with the offset account but by God, are they really worth that much? I say no. Which is why we are on the simplest, no frills, lowest interest rate loan possible. We also pay $0 in fees and always have, this is something I’ll cover in another post later [this post in fact] but for now…
That’s right! You didn’t think you were going to get away that easily did you? For this post your tasks are a little more complicated as there are a few things that the bank can throw at you whilst doing this.
If you are considering switching banks entirely for a cheaper loan, please don’t do this and instead make sure your new loan is a simpler one instead.
1. Call up your bank and find out what type of loan you’re on. [5 mins]
- If you’re already on the lowest interest rate loan with no offset account then awesome! You’re all done, go have a beer and start the BBQ.
- If not, find out what your interest rate currently is and also how much it will cost you if you were to “re-finance” or change the loan type (note this is to change to another loan at the same bank, not go else where)
2. Now ask them if there is a simpler, cheaper interest rate loan they can switch you to and how much that would cost. [5 mins]
- This should be the most simplest loan they have that also has a redraw facility, it would be wise and simple to look this up on their website before hand
- Note: Some banks can charge a “fee” to make a redraw (eg. $50) however as redraw’s should only be done for emergencies, I’ve never found this to be a problem
- The new home loan should still allow you to make any extra repayments you want. Make sure they don’t mind you paying twice, or even three times the “minimum repayments”
3. Weigh up the benefits. [30 mins]
- Using the new interest rate of the simpler loan, calculate how much you’ll save each year by not having that offset account. This is simply the loan amount * the difference between the offset and non-offset loan interest rates (7.01% – 6.5% = 0.51% in our example) or:
- $400,000 * 0.0051 = $2,040 saved per year
- Now compare this cost to how much the bank will charge you to re-finance your loan. Chances are it might be a few hundred dollars in fees however as you can see, it’ll be nothing compared to the savings you’ll get in interest
- Make sure you understand the features and benefits of both loans you are comparing, be sure to spend as much time as you need to fully take everything in
4. Pull the trigger [5 mins]
- Call up your bank and ask them to switch your loan type (BAM!)
5. Leave a comment saying how much you saved by using this advice to encourage others to do the same [2 mins]
Total Time: 47 minutes.
The benefits include: 1) How to pay off your mortgage faster than 99% of people with one hour a month of work 2) How to get rid of your debt and have the freedom to spend money on the things you love, guilt free 3) Clear outline of how to setup your expenses, mortgage and general finance 4) How offset accounts work and how to get the same result without being gouged by the big banks 5) How to cut through the crap and focus on the things that truly matter when taking down a mortgage 6) How to adjust the strategy so it works for you, even if you have kids, even if you only have one income 7) How to do all of these things and maintain a normal social life (and never be cheap).