What is an Interest Offset account and how do they work?

Written by Michael McAlary

Interest Offset accounts have become a standard feature in the home loan market. Yet we’re often asked what an Interest Offset Account is?

An Interest Offset account is a separate non-interest earning transaction account that is linked to the home loan account. The balance of funds held in the Interest Offset account is deducted from the home loan amount and interest is charged on the reduced balance.

The benefit of Interest Offset accounts is that while your Principal & Interest (P&I) repayment remains the same, the amount of interest payable has been reduced, with the difference used to reduce your loan balance. Over the term of your loan this can assist you in repaying your loan early, saving you thousands.

Interest Offset Accounts Are Complicated.

However, Interest Offset accounts work best when a considerable sum is consistently held in the account. To maintain the Interest Offset account balance, customer income is deposited into the account and day to day living expenses charged against a credit card with an interest free period. Once a month the balance of this credit card is paid from the Interest Offset account prior to the expiry of the interest only period.

The issues that need to be considered when considering a home loan product that comes with an Interest Offset account are:

  • The importance of being disciplined in managing the Interest Offset account each month. If borrowers are not disciplined the financial benefits will not accrue
  • Home Loan products with Interest Offset accounts are generally offered with a monthly fee or a higher interest rate
  • Depending on the size of the home loan the saving in interest is not significant compared to a basic home loan at a lower rate
  • Is it better to have a home loan product with a Redraw feature which allows you to access any additional repayments that you have made? Making extra repayments reduces the principal, and interest components of your loan
  • Funds in the Interest Offset account are readily available for other purposes such as investing, life’s emergencies and lifestyle purchases. It is important to recognise that if the funds are used for these purposes the benefits of Interest Offset account are diminished

The above factors are important when considering whether a home loan with an Interest Offset account is the right product for you.

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