The 100% Offset Account method, as well as Method 2 – Using a flexible Loan/Line of Credit, use the same principle.

Method 1 still requires you to make your monthly payment and your loan will thereby be reducing over time. Method 2, however, requires a certain amount of discipline and restraint, as you need only make the interest payments.

The principle both methods employ is to funnel all of your income and savings into a facility that will either:

• “offset” or annul the interest which is charged against a portion of the balance of your loan (method 1); or
• directly reduce the loan balance upon which interest is calculated (method 2)

Most people deposit their money into an every day savings account to pay for living expenses, bills, and as a place to store savings. Banks usually only pay in the vicinity of .01% to 3% on such accounts, and you have to pay tax on that.

By putting your money in a 100% Offset account, you will be putting it where it can work the hardest for you by offsetting the interest on your mortgage – tax free!!

Let’s use an example to best illustrate how a 100% Offset Account can slash years off your loan and save you $10’s of thousands of dollars in bank interest.

Grant and Diana are humble battlers.

• They both work and have a combined weekly after-tax take home pay of $770 (or $3337 p/mth).
• They have a $150K mortgage at 6.7% which they have taken out over 25 years.
• Their mortgage payment is $1032 p/mth, and they share a car so they get by on $400 p/week (or $1734 p/mth) to cover all their living expenses.

They restructure their accounts in the following manner:

• Instead of having all their income go into a separate savings account, they open a no minimum amount, low/no fee 100% Offset account which they link to their home loan and organise for both their pay-cheques to go into the Offset account. Some providers require that you have a minimum balance of $2000 or so before they apply the Offset so beware and shop around (see: Conclusion).
• They also apply for a no or low fee fee credit card with a $2000 limit (enough to cover their $1734 p/mth living expenses), a minimum 30 day interest free period, and organise with their finance provider to automatically payout the monthly balance of the card from the funds in their offset account at the end of the interest free period. This is known as a “sweep” feature – it’ll avoid you ever having to pay interest on the card balance as you won’t need to remember to pay the card out at the due date every month.
• They then make most of their monthly purchases using the card instead of using cash.

By structuring their finances this way, they will be having their full combined net salaries of $3337 per month sitting in their offset account for the month until the credit card balance is paid out. This will be effectively reducing the balance of their home loan, upon which interest is calculated daily, by $3337 for the month.

So what difference does this then make over time? Well, assuming they set and monitor their budget so that they don’t spend more than their $400 p/week allocated for living expenses, and assuming they pay all their bills via their credit card, the result will be that they will completely pay out their mortgage in 11yrs and 1mth (not 25 yrs), and will save nearly $100,000 in interest in the process.

Let’s look at the stats:

An Equity Loan, or Revolving Line of Credit as they are commonly referred to, applies the same principle as the 100% Offset account in that it enables every dollar of your income and savings to be used to reduce the mortgage interest.

However, it’s probably fair to say that an Equity Loan is only suitable for people who maintain a budget and STICK to it. There are three important considerations with using an Equity Loan for reducing your mortgage term versus using a 100% Offset account:

• Equity Loans are interest only loans and have no term, hence you are not constrained to ever pay it off
• Your credit limit is normally set by the bank or lender & normally is up to 90% of the value of your home, which could be hazardous for those who are tempted to stick their hand into the cookie jar for discretionary spending purposes!
• The interest rate on an Equity Loan is generally a little higher than for a standard fixed rate loan, maybe 0.5% , or more ,as an example
•  

For those who are disciplined, a number of advantages apply to Equity Loans:

• You can consolidate other loans and credit cards which are on a higher rate of interest into the lower rate Equity loan.
• They’re generally portable, hence saving you on application fees and establishment costs should you move house in the future
• More aggressive or sophisticated home owners could use their equity to invest at a higher rate of return & use the returns to pay off the principal on the debt faster.
• Putting aside the features and flexibility of these loans as detailed in that article, the example we used for Grant and Diana in Method 1 would yield essentially the same result if they had used an Equity Loan. They would still slash 14 years off their home loan and save nearly $100K in interest.
• A final word: if you spend more than you earn, then this is definitely not the option for you. Stick to a 100% Offset account.
• It’s best to do a budget first and set a goal as to how much you want to have paid off the loan at the end of each year. Put dates on your plan and work out what the loan balance will have to be at the end of each month in order for you to get there. And finally, and most importantly, after setting up your Home Equity Loan, review your expenditure against your budget plan monthly.

By simply paying 50% of their current monthly repayment fortnightly instead, they will save nearly $32,000 in interest and 4½ years off their loan.

This method can be far more effective in high interest rate regimes, which we are experiencing at present ,and can slash many more years off your loan than when the interest rates are low .