Home Loan Offset Accounts and Investment Properties
If you’re a property investor, you should always be exploring ways for your money to bring you the most value. Australia’s most successful property investors have the backing of a strong financial background or elite A-team to achieve their investment goals. One basic principle is that personal debt should always be paid before investment debt. What this means is that your personal loans, credit cards, and home loans should be the focus of your efforts. It’s tax efficient and should be followed before looking at making additional payments to your investment loans.
But let’s say you’ve already done this and sorted out your personal debt. Should you really be allocating your funds to paying the principal of your investment mortgage? The answer is probably no. Say hello to mortgage offset accounts.
What is a mortgage offset account?
Essentially, these accounts offer the same benefits you’d receive when paying off a mortgage but with one major difference. That is, the money you’re depositing can be withdrawn any time which means you can pay off faster but still retain access to your money.
Before we get into more detail, it must first be understood that this is different from the redraw facility your probably familiar with. A mortgage offset isn’t part of your loan – it’s basically a separate transactional savings account. However, instead of earning interest, the offset account ‘offsets’ the interest of that primary loan it is linked to. Let’s walk through the benefits of offset accounts in detail.
Let’s look at a little example.
You just bought a new investment property. Good stuff! However, you’ve now got a loan of $500,000 with a full offset account. You’ve played your hand well so also have $80,000 of savings that you decide to place into that offset account. Mr Bank will then subtract this $80,000 from the loan balance and only charge you interest on the balance, which is $420,000.
So the question is, why is this a good outcome for you?
- It’s more than likely that the interest rate you would have attracted on a savings account would have been lower than the interest rate that you’re offsetting.
- The interest on a savings account is taxable whereas the interest you’re offsetting against the loan isn’t.
But wait for a second, don’t mortgage redraw facilities get you the same result? Don’t they both create no tax burden?
The long answer is no, not really. Yes, don’t get us wrong, it’s possible to achieve the same outcomes from a redraw facility. However, there’s a level of convenience afforded by offset accounts and less risk when dealing with investment loans.
Redraw facilities are quite common and available to most home loans. It allows the borrower to pull out funds they’ve already made to pay down the loan’s principal. However, there are a number of reasons why this isn’t your best option.
- Almost all lenders set minimum amounts that can be redrawn. On top of that, you usually incur a fee when you redraw.
- You rarely get instant access to the funds.
- If your intention is to pay off other debt or bills, you’ll find that almost all redraw facilities lack completely transactional features like Bpay.
Now if you’re a property investor, there’s an even bigger problem with using a redraw facility as opposed to an offset account. Any funds you decide to withdraw using a redraw facility will contaminate your investment loan. This means that the ATO can jump in an deny you any interest deductions or initiate new limitations on the deductions you can claim throughout the life of the loan.
Let’s use another example.
Let’s say you withdrew $30,000 to go buy a car via a redraw facility. If the loan was $500,000, then it’s likely the ATO would take a look and say, hey, 94% of the loan is tax deductible for the life of the loan.
You wouldn’t encounter this tax issue if you were to use an offset account. Reason being, the offset account is a separate facility of your loan. You could actually withdraw as much as you like from the offset account for personal use and your loan is still 100% deductible.
This is the reason why most accountants encourage offset accounts.
There are other scenarios where offset accounts do come in handy. A common one is you’re moving to a new property (in other words, you’re changing your Principal Place of Residence – PPR) but wish to convert your existing property to an investment property.
Normally you would have been paying toward your home loan but when you move to your new property, your new loan is likely to be much larger than the existing one which is now classified as an investment. This results in what is known as an ‘upside down’ loan as you end up with a very large personal debt on your new loan and a smaller tax-deductible investment debt on the first property. This isn’t ideal.
If your goal is to convert your existing property into an investment property you should probably consider the following when speaking with your accountant or mortgage broker.
- Set up interest only loan for your PPR with a 100% offset account
- Instead of paying towards the principal, you’ll instead direct all your income and savings to the offset account.
- Once you’ve got your new property, use the funds in your offset account to decrease the debt of your new property and maximise the interest payments, that are now tax deductible, on the original property.
There are advantages and disadvantages to this and some lenders are offering decent interest rates on principal and interest loans. Every borrower has unique circumstances and it’s best you talk to a finance professional or mortgage broker before deciding on the best product.
To summarise, there are some big advantages to using an offset account on an interest-only loan.
- Lower repayments. As the name suggests, you’re only paying the interest of the loan and your repayments will gradually become lower and lower so that you can free up some cash for other investments.
- Tax deductions. If the purpose of your loan is an investment, you can claim tax deductions. To claim the interest as a tax deduction, you’ll need to shift your efforts to reduce the interest payable on the non-deductible debt.
- Debt separation. An interest-only loan allows you to keep your original debt separate. You can then move your savings into the offset account to counter any debt that isn’t tax deductible.
- Contingencies. If you do experience a lifestyle change, you now have a buffer thanks to the offset account.
If you’re keen to explore this idea further, you’ll need to talk to a mortgage broker, financial planner or tax specialist. Before heading there, calculate how much you think you can deposit into your offset account each month and figure out how and if an offset account benefits you.
If you already making additional repayments during any interest-free period, and you’re able to cover these repayments post-interest free, then the offset structure is worth considering.