How a Savings Account Works
A savings account holds deposited money and earns interest on that balance. The interest rate is set by the bank, varies over time, and may be conditional on specific monthly behaviours (the bonus rate structure described in Dispatch 11). Interest earned is credited to the account, usually monthly, and is treated as taxable income in Australia.
The effective benefit of a savings account is the interest rate less your marginal tax rate — because the interest you earn is taxed at your marginal rate. For someone on a 32.5% marginal rate, a savings account earning 5% per annum generates an after-tax return of approximately 3.375%.
A savings account is available to anyone — you do not need a mortgage to hold one, and the money in it is yours independently of any other financial product.
How an Offset Account Works
An offset account is a transaction account linked to a home loan. The balance in the offset account reduces the principal on which interest is calculated for the loan. If you have a $350,000 outstanding mortgage balance and $25,000 in an offset account, you pay interest on $325,000, not $350,000.
The financial benefit of an offset account is the interest you avoid paying on the mortgage — at the mortgage interest rate. Because home loan rates are typically higher than savings account rates, the same dollar held in an offset account may generate a greater benefit than the same dollar held in a savings account. Additionally, avoiding mortgage interest is not a taxable event — unlike savings account interest, which is taxable income.
Offset accounts are generally only available on variable-rate home loans from certain lenders. Some fixed-rate loans allow partial offset; others do not. An offset account's effectiveness depends entirely on the gap between your mortgage interest rate and the savings rate you would otherwise earn.
When Each Tends to Be More Appropriate
An offset account tends to be the more financially effective option if you have a variable-rate home loan, if the mortgage rate is higher than available savings account rates, and if you are comfortable using a transaction account as your savings vehicle (offset accounts typically function as everyday accounts, not as separate savings accounts with conditions).
A savings account is more appropriate if you do not have a mortgage, if your loan does not support offset, if the loan's offset fee outweighs the benefit, or if you prefer to hold your savings completely separately from your loan — which some people find clearer psychologically.
There is also a practical consideration: offset accounts are generally only available at the bank that holds your mortgage. If you have a mortgage with one bank and prefer to keep your savings elsewhere, an offset account is not an option for those funds.
Questions to Ask Before Deciding
Does your home loan support a full offset account, or only a partial offset? What fee, if any, does the lender charge for the offset facility? Some lenders charge a monthly fee for offset accounts, which reduces the effective benefit.
What is the current interest rate on your home loan? What is the best available savings account rate you could access? The difference between these two numbers — adjusted for tax — determines which option produces a better outcome.
Are you close to paying off the mortgage? As the loan balance decreases, the absolute benefit of an offset account decreases proportionally, since there is less interest being calculated.
If you are unsure which option suits your situation, speaking with a licensed financial adviser who can review your specific loan terms and tax position is the appropriate next step. ASIC's MoneySmart website (moneysmart.gov.au) also provides independent explanations of both products.
What this dispatch does not do
- Recommend specific offset account products or home loans
- Provide tax advice or calculate your tax outcome
- Recommend one option over the other for your specific situation
- Provide personalised financial advice
