How does an offset account work?

An offset account lets your savings reduce your home loan interest while you keep the money in a separate bank account. Whether it is worth paying for comes down to your usual balance, the loan's interest rate and its fees.

Start with the amount you expect to keep after bills, holidays and other planned spending. A $50,000 balance on settlement day will not deliver a full year's savings if most of it is spent on renovations next month.

With a 100% offset, a $400,000 home loan and $50,000 in the linked account means interest is calculated on $350,000. You still owe $400,000. The money in the offset has not repaid the loan.

Interest is generally calculated daily. A deposit starts helping once it is included in the lender's daily calculation; a withdrawal reduces that benefit. You can usually receive your salary, pay bills and use a debit card from the account. Westpac explains this daily calculation.

On a principal and interest loan, the scheduled repayment usually stays the same. Less interest means more of that repayment goes towards the debt, which can shorten the loan term if you maintain the benefit. An offset does not lock in your rate or prevent repayments rising when a variable rate increases.

The first diagram shows a full offset on a $500,000 loan: $50,000 in the offset account leaves $450,000 attracting interest.

The comparison below uses a $400,000 loan and $20,000 in offset savings. A 100% offset leaves $380,000 attracting interest. With a 50% partial offset, only $10,000 of those savings counts, leaving $390,000 attracting interest.

Both can reduce interest. Money in an offset stays in a separate deposit account. Extra repayments reduce your actual loan balance; redraw lets you borrow eligible extra repayments back, subject to the loan's rules. ANZ explains the distinction.

At the same rate, $20,000 in a full offset and a $20,000 extra loan repayment initially reduce the interest calculation by the same amount. The distinction is access, cost and how the money is treated, including for tax.

Do not assume redraw is either always instant or always an application. For example, NAB publishes minimum redraw and eligibility conditions, while ANZ explains that a redraw increases the debt again. Check your own contract before relying on redraw for an urgent bill.

Use this starting estimate: average offset balance × annual loan interest rate. It estimates the direct interest reduction before fees, while the loan balance remains above the amount offset.

These examples use an illustrative 6% annual rate and a 100% offset. The rate is an assumption, not a current lender offer.

The monthly column is an annual average, not the saving for each calendar month. Rates, daily balances and month lengths affect the actual result. These figures exclude fees, tax effects and the additional interest benefit as repayments reduce the debt faster.

Suppose your home loan is $400,000 at 6%, with $50,000 in a full offset. Holding both balances unchanged for 30 days gives this comparison, using a 365-day year:

Now suppose you keep $50,000 there for 15 days, then withdraw $30,000 and keep $20,000 for the next 15 days. Your average offset balance is $35,000, and the direct saving falls to about $173 for the 30 days. Dollar amounts are rounded.

Making more deposits does not create an extra reward by itself. The balance available each day determines the saving. A steady $50,000 can save more than frequent deposits into an account that is usually almost empty.

At a constant 6%, $50,000 held in offset produces $3,000 in direct annual interest savings while the eligible loan balance remains at least $50,000. Multiplying that by 20 gives $60,000, but that is not a reliable forecast of total savings or years taken off a loan.

A longer-term comparison needs the loan balance, remaining term, repayment amount, future offset balance and rate assumptions. It must also stop counting offset benefits beyond the eligible debt. Use our extra repayments calculator to explore paying down debt, and ask us to model an offset separately with your expected cash balance.

Ask for the total cost of an offset loan and a comparable loan without offset. Check the annual package fee, monthly account or offset fee, and any difference in the loan interest rate. Include switching costs if you need to refinance to get the feature.

Some lenders charge a monthly offset fee rather than a package fee. For example, CommBank's offset information sets out which eligible loans and account charges apply. Use the terms for your actual product; a fee on one loan is not the rule for every loan from that lender.

If the offset adds $120 a year and both loans have the same 6% rate, the fee-only break-even balance is $120 ÷ 6% = $2,000. Keep an average $5,000 there and the estimated direct saving is $300, leaving $180 after that extra fee.

That comparison assumes your cash would otherwise earn nothing. If it could earn savings interest, include that alternative after tax.

Assume a $400,000 loan without offset costs 5.80%, while an offset loan costs 6.00% plus an extra $120 a year. The difference is 0.20 percentage points. These are hypothetical offers with otherwise matching terms.

The approximate break-even offset balance is ($400,000 × 0.20% + $120) ÷ 6.00% = $15,333. That is much higher than the $2,000 fee-only threshold.

This simplified annual comparison holds balances and rates constant, ignores amortisation and assumes the cash on the no-offset option earns nothing. It does not compare putting that cash into redraw. Have both alternatives calculated before paying more for an offset feature.

Speak with your tax adviser before moving large savings into the loan or redrawing them. The property's security does not, by itself, decide whether interest is deductible.

The ATO's redraw ruling treats a redraw as a new borrowing. If you redraw for private spending, interest on that portion may remain private even when the original property is rented out. Mixing investment and private borrowings can mean ongoing apportionment and record-keeping.

An offset withdrawal uses money from a separate account. It does not create the same new borrowing as a redraw, but an offset does not automatically make a loan deductible. Your adviser still needs to check the original borrowing, later transactions and how the property is used.

If interest on an investment loan is deductible, an offset also reduces the interest expense you can claim. You cannot claim the interest you avoided paying. The ATO's offset ruling limits the deduction to eligible interest actually incurred.

A savings account pays interest, which generally needs to be included in your tax return. A standard offset reduces loan interest instead. For your own home, compare the mortgage interest avoided, less extra loan costs, with savings interest after tax.

For illustration, $20,000 earning 5% produces $1,000 gross interest a year. At an assumed combined marginal tax and levy rate of 32%, that leaves $680. The same $20,000 fully offsetting a home loan at 6% avoids about $1,200 in direct interest before extra fees and any loan rate premium.

Those rates and tax assumptions are examples, not a recommendation. For an investment loan, account for the reduced interest deduction as well. Check savings account bonus conditions and withdrawal access before comparing the returns.

A transaction account with the same bank is not necessarily linked as an offset. Confirm the link in the app, online banking or with the lender, then check how the saving appears on your statement.

Repeat that check after refinancing, splitting the loan or changing products. MoneySmart warns that a broken or missing link can leave customers paying more interest while their repayments appear unchanged.

Paying your salary into the linked account and leaving bill money there until it is needed can help. You do not need a credit card strategy to use an offset. Only consider one if you can pay the card in full by the due date without overspending; card interest and fees can outweigh the mortgage saving.