Interest Offset Accounts
Sometimes debt does not need to be paid off; it simply needs to be offset.
Interest offset accounts are a great way to manage debt. They introduce a flexibility to a client’s debt management that can be a great benefit down the track.
With an interest offset account, a loan account (usually a ‘mortgage’ account) is connected to a normal savings or transaction account. The amount of interest payable on the loan account is calculated by subtracting the balance in the offset account from the amount owing on the loan. So, if the loan account has $110,000 owing on it, and the offset account has $10,000 in it, interest is only payable on $100,000.
In terms of interest expense, therefore, money saved into the offset account has the same effect as money paid off the home loan. But, because the saved money is in a separate account, it can be accessed immediately, without having to make a redraw on the home loan. Amongst other benefits, this means that the main purpose of the home loan remains buying the property. This can be of great benefit to best-practice tax planning. Let us explain:
Suppose a couple buy a property worth $500,000. They have $100,000 in cash. They use $50,000 as a deposit and they borrow $450,000. They use an offset account and live in the property. Immediately, the amount that they are paying interest on is reduced to $400,000 by the $50,000 in the offset account. Over the next five years, they simply pay the interest on the loan account. Instead of paying down the principal, they save an extra $200,000 into the offset account. Effectively, then, they have reduced their debt to $200,000, because this is the amount they pay interest on.
After five years, they still owe the bank $450,000, but this is offset by the $250,000 that they have in their savings account.
The couple then decide that they want to buy another property to live in, but keep the first property as an investment. They take the $250,000 in the offset account and use it as a deposit on the second property, borrowing the rest (with another associated offset account – they can of course do the whole thing again). This means they are now paying interest on the full $450,000 borrowed on the first loan, which was taken out to buy the first property. Because this property is now rented, the interest paid on this account is now tax deductible. The $250,000 in cash has been used to reduce the interest payable on the loan required to buy the second property. This interest is not tax deductible.
You can see, then, how the offset account has the effect of letting the couple move ‘equity’ from the first property to the second one, but without needing to transfer title, incur stamp duties, etc.
The average period of owning a home is just on ten years. For units the period of ownership is even shorter. This means that most homeowners will move house several times across their lifetime. Buying-and-then-not-selling homes can be a simple and cheap way to develop a substantial property portfolio. Offset accounts let this be done while minimising transaction costs.
So, if you or someone you know has a home loan, please contact us to discuss how this loan can be best structured to allow you to have your cake and eat it too – or, to pay off your loan and keep the cash for the next one, as well.
