The conventional wisdom around offset accounts tells you to park every spare dollar in your offset, then spend directly from the account – this way you ‘maximise’ the amount of money in your offset account and save the maximum amount of interest. We recently had a client that followed this strategy, but we found it was actually costing them almost $24,000 a year.
The odd part was that the maths wasn’t wrong. The mistake came from what the offset account was doing to this couple’s spending without them noticing. It’s the kind of mistake that looks ‘sensible’ right up until you actually crunch the numbers (and add up the damage).
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Our couple was saving interest, but overspending was eating up all the benefits, and then costing them a heap on top for good measure – which you can see in their numbers.
This couple had worked hard to build up their savings, and had around $50,000 in the offset account attached to their investment property. Based on a 6% mortgage interest rate, holding the funds in their offset account was saving them around $3,000 in interest costs each year.
But when we looked at what was actually happening, our couple were overspending by on average $2,200 each month. Over the course of a year, this totalled $26,400 in extra spending, and even when you add back the offset interest saving of $3,000, they were still behind by $23,400 each year.
The point here is that the interest saving can be real, but the behaviour cost can still be bigger.
There’s one annoyingly common factor that drives so many people into this trap. When your everyday spending card is linked to an account with a big balance, you feel wealthier. Because each time you spend money the amount looks small relative to your account balance.
Research shows that spending behaviour changes when someone feels like they have more money, even when their income is the same. An offset account can create this exact effect, because your balance stays high and it feels like you always have more money.
And it gets worse if you spend on a credit card, even if you pay it off in full each month from your offset account. Cashless payments reduce the ‘pain of paying’ so spending feels less immediate, and a heap of studies have shown that people spend more when they spend on a credit card, rather than with their actual cash.
Stack these together and you’ve got a problem. A big offset balance makes you feel good, and a credit card softens the feeling of your spending.
Research shows that spending behaviour changes when someone feels like they have more money, even when their income is the same. (Source: Ben Nash/Yahoo Finance/Getty)
The fix for our couple wasn’t to get rid of their offset account, it was separating money that’s supposed to be spent from money that shouldn’t be.
To make this happen, our couple set up a bank account budgeting system, by first deciding on a weekly spending number for their discretionary spend – eating out, entertainment, shopping, and general stuff that comes up. If you’re playing along at home, the important thing here is that you pick a realistic number you can actually stick to.
Next, you want to automate a transfer each week to a separate debit account, which now becomes your ‘guilt-free spending’ account. This avoids using your offset account as the default, and puts a small guardrail around your spending. And if you’re the sort of person who has a tendency to ‘borrow’ money from your savings, consider adding in an extra layer of friction like holding your guilt free spending account with a separate bank altogether. It won’t stop you from breaking your budget, but it will force you to stop and think.
And the final element is to keep your real savings and buffer money in your offset account, so you get all of the interest-reducing benefits of this type of account.
This works because splitting your money into visible bucks changes your behaviour, because the boundary is now obvious, not just implied.
Pro Tip: If you follow this sort of set up but your offset account balance never really moves and you still feel broke, that’s a clear hint that your spending is drifting. If this happens, revisit your numbers, park your credit card at home and off your phone pay set up, and review your spending weekly to see where things are going wrong.
Offset accounts are a great tool to help you cut your mortgage interest costs, and the maths says they’re the best place for your spare cash. But they can become a trap when you use your offset as your spending account, and this gets worse if you combine your offset with spending on a credit card.
If you want the interest benefit without the budget blowout, one of the most effective approaches is is to keep your offset account for true savings, then pay yourself guilt free spending into a debit account with a weekly budget. You still get the interest savings on your main bucket of money, but you avoid the behaviour trap that can sabotage your savings.
Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth. You can learn more about how to be smart with your money through Ben’s book Replace your Salary by investing.
If you want some help with your money and investing, Ben has created a free seven-day challenge you can use to get more out of your money you can join 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.
