How to Benefit From Compound Interest

What is an Offset Account?
It is an account that allows you to put all of you money into it, which then offsets the interest on your home loan. As most lenders calculate interest daily and charge it monthly you get the benefit of reducing the calculated interest each time you put money into the offset account.

In today’s economic market you must have these sort of facilities in order to help you reduce your loan balance faster. An offset account is a lot safe for the majority of Australian consumers than the traditional line of credit. Be sure that your offset account is 100% offset and not a partial offset account.

How does it work?
Your home loan interest is calculated at the end of each day on the balance owing on the home loan. At the end of the month the interest is then added onto the loan balance for that month.

Traditionally you would pay your loan each week/fortnight or month and leave the remainder of you money in a bank account for future use. This means that the bank calculates the interest for your home loan on the newer balance.

A home loan with an offset account does the same thing only that the remainder of money in your bank account after paying the home loan payment is also taken into consideration for the interest calculation at the end of each day. Makingcentsaddup 

Example:
Home Loan $400,000 Interest Rate 5.00%
If you made 1 home loan payment of $1500 at the end of the month, but you deposited $1000 in your offset account each week building up to $4,000, by the end of the month the home loan would be calculated below.

$400,000 Loan Balance
Balance Now for week 1 interest would be calculated on the loan balance of $400,000 less an additional $1000 sitting in the offset account, so interest would be calculated on $399,000 and so on for each week for the month.

Wk 1 Interest $382
Wk 2 Interest $381
Wk 3 Interest $380
Wk 4 Interest $379
Total Interest $1,522

Now if you just paid your loan once a month the interest on your loan would be $1,540.
So as you can see there is additional savings over the life of the loan.

Offset Advantages:
For personal borrowers, using your saving to offset the interest on your home loan is far more effective that putting it into a interest bearing account. The reason for this is that on interest you earn you will have to pay a portion in tax whereas expenses that you avoid (offset interest) are not.

Offset Disadvantages:
Your probably thinking “what disadvantages”, well there could be additional account fees and charges (ensure your broker gets you the right account for your needs), also what I find a lot of Australians doing is that they start to see their bank (offset) balance growing and they do 1 of 2 things.

1. They start spending
2. They stop saving so much

Both results are negative to your debt reduction plan for your home loan.

We always encourage our clients to transfer the excess money from their offset account into their home loan (with a redraw facility attached) every 3 months thus causing them to feel they need to build their bank balance again.

 

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