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I've been looking into my finances lately (I am an armchair finance person).

And it looks to me, that my return on investment isn't going to be the same, if for example, I put $12000 in an offset for a year OR pay an extra $1000 a month, for 12 months off my loan.

ROI on paying extra to mortgage

Firstly I go here: https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/mortgage-calculator#!how-can-i-repay-my-loan-sooner

I enter:

owing: 250,000 Repayment: 2,000 Monthly, Interest Rate: %3.36

The calculator gives back:

Time Till Completion: 12yrs 11mnths, Interest Paid: 58,133

Then I think about the $12000 dollars. If I pay an extra 1000 a month over the next year 1000*12=12000:

I enter:

owing: 250,000, Repayment: 3,000 Monthly, Interest Rate: %3.36

The calculator gives back:

Time Till Completion: 8 years, Interest Paid: 35,080

So I'm saving 58133 - 35080 = $23053 over 8 years, next I get a yearly return number 23053/8=2881.62.

Finally it looks to me like 2,881 is 24% of 12,000 Said in another way, my yearly ROI for $12000 is 24%.

ROI on leaving cash in offset

Firstly, again, I tried to get a calculator to do the heavy lifting for me: https://www.ing.com.au/home-loans/calculators/offset.html

I enter:

Loan Amount = 250,000, Loan Period = 13 yrs, Interest Rate = 3.36%, Offset Account Balance = 12000

The calculator gives back:

Interest could save = $6,347.32

Get a yearly return 6,347/13=488.23. So it looks to me like 488.23 would be my yearly return on putting $12000 in an offset. Which is a yearly ROI of 4.06%

This leads me to believe paying of an account is much more beneficial than putting funds in an offset. Is this correct? Am I missing something?

I always believed using an offset account or paying of a loan faster would equate to "saving" the same amount of money in the end.

  • Seems like you are comparing lump summing $12000 vs contributing $1000 a month for 12 months, and this is what is causing the difference. – void_ptr Dec 30 '19 at 6:33
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This leads me to believe paying of an account is much more beneficial than putting funds in an offset.

Is this correct?

Yes

Am I missing something?

Nope.

The money accumulating in the offset account is just sitting there growing at 0% while the mortgage balance is growing at 3.36%.

If you could find liquid security which guaranteed you 3.36% after taxes then the ROI on that would be a "break even" compared to paying the extra $500/month (though with extra work). Anything higher than 3.36% and you'd "win".

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    Offset account balance reduces interest, and hence makes more money go towards principal balance. Thus, in a way, money in offset account grow at the same mortgage interest rate - it is just that these gains get in effect automatically "reinvested" into the mortgage, so you don't see them in the offset account. – void_ptr Dec 30 '19 at 6:37
  • @void_ptr what's to stop you from withdrawing money from the offset account? (That's what confused me when reading about them.) More importantly, what's the point of an offset account? – RonJohn Dec 30 '19 at 7:50
  • The point of an offset account is to offset interest-bearing principal balance of a mortgage, while keeping the money in a liquid form. Nothing stops you from withdrawing that money (but not gains on it, because they get locked in the mortgage). – void_ptr Dec 30 '19 at 14:48
  • @void_ptr so the offset account accrues interest, but that interest is automatically applied to the mortgage balance? – RonJohn Dec 30 '19 at 21:38

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