There are two features of a home loan that can be used to reduce interest payments – either a line of credit or an offset account. Mathematically they are exactly the same, but which one you prefer is simply a matter of choice.
So what is the difference between the two and how do you successfully manage these to your advantage?
What Is A Line Of Credit?
A line of credit (often referred to as an LOC) is a variable rate loan facility secured by a mortgage over a property. An LOC basically operates like a credit card but with a very large credit limit and much lower interest rate.
Interest is payable only on the funds drawn and the minimum repayment each month is simply the interest on the outstanding balance.
Used well, an LOC can benefit property investors and home owners as the unused portion of the facility means you have funds ready for any purpose, such as renovating an existing property, funding a deposit for a new one, debt consolidation, paying school fees, going on a holiday, and in some cases as a capital injection into a business.
However, that flexibility also creates a risk. If you have a history of maxing out your credit cards, a line of credit may mean you’ll be tempted to do the same on a much larger scale. Misusing an LOC can lead to serious financial hardship.
What Is An Offset Account?
An offset account is a transaction account that is linked to your home loan. It can be an effective way to reduce loan interest.
Rather than earning interest on the account, either every dollar in the offset account is offset against the loan balance, or a proportion is offset. This works to reduce interest charges.
Example: With a 100% offset account, if your account has a balance of $40,000 and your loan has a balance of $400,000 then interest on the home loan will be calculated on $360,000. This amount is recalculated each month on the day your mortgage payment falls due.
While the money in the account is available at call anytime, it’s obviously in your best interests to keep an offset account topped up. It’s a good idea to have all wages, rental payments and other monies owing to you automatically directed into the account.
So in that sense the line of credit and offset are the same, i.e. you only pay interest on the net amount you have outstanding.
Are These Facilities Right For You?
Whether these options are good or evil depends on how savvy you are at managing them.
Manage them well and the long-term financial benefits will accrue, manage them irresponsibly and you are heading for financial difficulty down the road.
Above all, you should seek unbiased expert advice.