What Is an Offset Account and How Does It Work?

An offset account is a financial product that helps individuals with a home loan reduce the interest paid over the life of their mortgage. Linked directly to a home loan, it operates to create interest savings. While not as widespread in the United States as in some other countries, these accounts offer a unique approach to managing debt and savings simultaneously.

Understanding Offset Accounts

An offset account serves as a transaction or savings account directly tied to a home loan. Its purpose is to lower the principal amount on which your home loan interest is calculated. The money held in this separate account is effectively “offset” against your outstanding mortgage balance, reducing the interest charged on your home loan instead of earning interest on savings.

For example, if a homeowner has a $300,000 mortgage and maintains a $50,000 balance in their offset account, they would only pay interest on $250,000 of the loan. This arrangement allows savings to actively work against mortgage interest without being directly applied as a loan payment. The more funds maintained in the offset account, the greater the interest savings over time.

How an Offset Account Works

The mechanics of an offset account involve how interest is calculated on your home loan. Instead of the lender calculating interest on the full outstanding loan principal, the balance in your offset account is subtracted from the principal amount daily. The interest for that day is then calculated on this reduced, or “net,” principal.

Consider a home loan with an outstanding balance of $400,000 and an offset account holding $50,000. On any given day, the interest would be calculated on $350,000 ($400,000 – $50,000). This daily calculation means that even small, consistent balances in your offset account can accumulate significant interest savings over the loan term. While your regular loan repayment amount remains the same, a larger portion of that payment goes towards reducing the actual loan principal, rather than just covering interest charges. This accelerated principal reduction can lead to paying off the loan earlier than scheduled.

Key Characteristics of Offset Accounts

Offset accounts offer immediate accessibility to funds, similar to a standard checking or savings account. You can deposit and withdraw money as needed, often using a debit card or ATM. This flexibility allows homeowners to keep their emergency savings or regular income in the offset account, making their money work harder by reducing mortgage interest.

These accounts are linked to a specific home loan, with the same lender. Offset accounts themselves do not earn traditional interest; the benefit comes from the interest saved on the home loan. Most offset accounts are “100% offset,” meaning the entire balance in the account offsets the loan principal. Some “partial offset” accounts exist where only a percentage of the balance is used to reduce the loan principal for interest calculation. Offset accounts may also come with associated fees, such as annual fees or transaction charges, which should be weighed against the interest savings.

Offset Accounts Versus Redraw Facilities

Offset accounts and redraw facilities both offer ways to reduce interest paid on a home loan, but they function differently. An offset account is a separate transaction account where your savings reduce the effective loan principal for interest calculation. The funds remain in your accessible account, and you only pay interest on the difference between your loan balance and your offset balance. This arrangement maintains liquidity of your funds while simultaneously lowering your interest burden.

In contrast, a redraw facility allows you to make additional payments directly into your loan principal beyond your scheduled repayments. These extra payments reduce the actual loan balance, which in turn lowers the interest charged on the reduced principal. If you later need access to those extra funds, a redraw facility allows you to withdraw them, essentially reversing a portion of your principal payments. While both methods save interest, offset accounts keep your money separate and accessible like a bank account, whereas redraw facilities involve paying down the loan directly and then re-borrowing those specific extra payments if needed.