Common bank habit a conspiracy making Aussies pay mortgages for longer: 'Dark side'

Offset accounts are promoted as the way to make the most out of your mortgage, but for many people, they can cost you serious dollars. And the more I think about it, the more I feel like offset accounts could potentially be a bank conspiracy to keep you paying more mortgage interest for longer.

It makes sense to take advantage of all the products you have available to get ahead. But the most important thing is that you’re using them in the right way - that will actually deliver results for you.

What is an offset account?

An offset account is a bank account that’s linked to your mortgage.

How they work is that every dollar that’s sitting in this account has the effect of ‘offsetting’ how much money you owe on your mortgage, which is achieved by reducing the interest costs on your debt.

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For example, if you owe $500,000 on your mortgage and have an offset account with $50,000 deposited, the bank will calculate your interest costs based on the ‘net balance’ of your offset account and mortgage.

In this case it would be $500,000 less $50,000, or $450,000.

How are offset accounts promoted?

Because of the interest savings on offer, the banks typically suggest you hold as much of your money as you possibly can in your offset accounts.

When you do this, it means your net mortgage balance is as low as possible - and therefore your mortgage interest is lower as a result.

There are two main ways offset accounts are suggested to be used, and both of them are fraught with challenges.

The first is that you get your salary deposited directly into your offset account, and try to keep as much money as possible in this account.

The suggestion is typically that you pay all your bills from your offset account, and use this account for your general spending.

Advocates of this approach talk about the fact this would keep a higher balance in your offset account for longer, because you only take money out of the account when it’s needed for your spending.

The second approach is similar to the first in that you have your income deposited directly into your offset account, but instead of using this account directly for your spending you run this on a credit card.

You then pay off your credit card in full at the end of the month so you don’t pay any credit card interest, and in this way you keep even more money in your offset account for longer.

The logic of these two approaches is solid, but their practical application can lead to some serious trouble.

The dark side of offset accounts

The challenges with this approach aren’t immediately obvious, but having helped thousands of people with the management of these accounts over the last decade, plus I’ve seen this cause countless challenges.

As a self-confessed money nerd I geek out on behavioural finance, and there are a number of studies that have proven the challenges of following the approach outlined above.

Most of them boil down to one inbuilt tendency everyone has at some level.

The problem with this approach is that we have a tendency to consume what we have available.

When you have a lot of food available, you tend to eat more.

When you have more time to get something done, you tend to use it all.

And when you have more money in your bank account, you tend to spend more.

Using offset accounts in the way outlined above, you have a bank account with a high balance.

When this happens, you feel like you have more money, and you tend to spend more.

You save less as a result, and ultimately this slows down your progress getting ahead.

What can you do instead?

This may be a little controversial with finance people, but I’ve found an approach that is consistently more effective for most people.

This approach involves using multiple bank accounts instead of keeping all your funds in one offset account, and specifically that you have three specific accounts for different types of spending.

The first is your pocket money account, which covers all personal day-to-day spending for yourself or your household.

I’ve found that by having a separate account for this money where you deposit only your budgeted weekly spending allocation, you set clear guardrails and effectively create ‘guilt-free’ spending.

The second is your long-term savings account, and with this account, it’s ideal if you can keep the money in an offset account.

This account will hold the money you don’t need for your spending, and should only build into the future.

By having this money completely separate from all of your other funds, you will benefit from a motivational boost seeing the money only increase and never go down.

The final account is a short-term savings account, i.e. savings that you plan to spend.

This might be for things around the house, Christmas gifts, or your next holiday.

Having the money for this spending completely separate from your savings will mean that when it comes time to spend, you won’t feel guilty about dipping into your long-term savings.

In my experience, when you follow this approach you typically spend less money in this category because you’re spending from an account with a limit as opposed to your larger main pot of savings.

Following this approach with multiple accounts may mean you hold money in an account which isn’t an offset account - technically this does mean you’re paying more in interest costs.

But in my experience, people following this approach save thousands of dollars more each year.

And I can tell you for sure that saving a thousand extra dollars through your savings will always beat saving $100 in interest costs.

Sometimes the conventional ‘wisdom’ isn’t that wise.

The wrap

Offset accounts can be an effective way to save on interest costs and get ahead with your money.

But if you’re using offset accounts, it’s important you do this in a way that will actually work for you.

There are a lot of myths in this space, and the most common approach doesn’t necessarily mean it’s the most effective one.

Having a savings system that actually helps you get ahead is crucial, and for most people being good at saving often means making much faster progress than what you could possibly save in interest costs by holding a few extra dollars in your accounts for a week or two longer.

Take the time to create a system that works for you, and your future self will thank you for it.

Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth. Ben is about to release his third book, Virgin Millionaire; the step-by-step guide to your first million and beyond.

Ben runs regular money education events to help you save more and invest smarter. You can check out all the details and book your place here.

Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.