What is equity? 

Equity is the difference between the value of  your home or investment, and the amount you still owe the bank. To put it simply... how much of the property you own - not the bank!

How do I use it to invest? 

You can access ‘some’ of your equity for investment purposes or even to buy a new car. However, you need to remember that the bank always wants  to have a margin between the loan and the value of your house. This margin protects them  against property price fluctuations in the event of foreclosure. As a result, you can only use the equity left available after the margin. The good news  is that if you have sufficient equity, you can fund the deposit and costs on an investment property. This is the most common method of investing; ‘access equity’. If you’re in a good financial position and have accrued some equity in your property, then investing can become quite accessible for you. 

How can I figure out how much equity I have to use?

A simple calculation on how much equity you could use without attracting big fat fees such as lenders mortgage insurance, is to take your estimated value of your property, multiply it by 80% (or 0.80 on a calculator), and then deduct how much you have left on your mortgage balance. If the figure is positive you could be using that equity without fees to perhaps leap-frog another property. Now remember, just because you have equity doesn't mean you should borrow it for other purposes - that would make you an equity eater and to build wealth we must genereally build equity, not eat it. You can leverage equity at more then 80%, but beware, as your investment strategy will attract lenders mortgage insurance fees, and expose you to more risk with property price fluctuations.

How does investing in  property work?

With the tax benefits of depreciation, and negative gearing, you can invest in property without a massive drain on your weekly finances. You can even claim the tax savings from property as you go through your pay. This is how regular people on regular wages buy and invest in property to grow wealth.

The tax advantage of the offset account

Buying a home to live in, whether it’s your first home or an upgrade can be an exciting transition. However, during this exciting  process, try not to overlook your 5 or 10 year plan.   So many times the property you are purchasing to live in, later becomes  an investment property when you opt to upgrade to a larger home to accommodate a  growing family.

If you feel that this is even a remote  possibility, there is a key loan feature that you should be activating, that could save you tens of thousands of dollars in tax.

The feature I’m talking about is your “100% offset  account”, which is where any additional payments over and above the minimum should be directed. The alternative option that many use, is to pay the extra repayments directly into your home loan, where they become available on a redraw account, this is the option I want you to avoid. If the loan is variable (or at least, the part of the loan the offset account is linked to) the interest savings is exactly the same, so there is no drawback to using the offset account. Let me explain the massive hidden advantage however...

What is an offset account?

Firstly let’s make sure the basic premise of offset account is understood. An offset account is a separate account to your home loan, which is linked in the banks computer systems, so that the balance held in the offset account, is daily, offset against the interest accruing on your home loan. For example, if you set $10,000 into your home loan offset account for a month, on a loan of 6.90% interest, you would save around $57 interest for that month. The effect of placing this amount directly into the redraw account of the loan is exactly the same (for a variable loan) interest  savings.

So why use an offset as opposed to redraw?

The benefit I’m referring to here is a tax advantage should the property become an investment. To best illustrate let’s use an example.  Stephen buys his first home for $350,000, with a $300,000 mortgage. The mortgage is fully variable with an offset account linked.  Stephen has indicated to me that in around 3 years he will move out and rent
this property. Therefore I have instructed Stephen that if he is going to make extra repayments, then to fund them into the offset account. After three years Stephen has put $40,000 into his offset account as extra repayments. He is
buying a new property to move into and will keep the home as an investment. He  plans to use the $40,000 to go towards the deposit on his new home, so will withdraw this from his offset account. For arguments sake, let’s say the home loan is still $300,000 large, with $40,000 in an offset account. Stephen is  accruing interest on $260,000 daily. When he withdraws the $40,000 from the offset account, he will have $300,000 balance, with $300,000 accruing interest again. In this scenario, the whole $300,000 is tax deductible now that the property is an investment.

In the second scenario, Stephen pays the $40,000 over three years directly into the home loan. When he moves to the new house,  the home loan balance is $260,000 and he is accruing interest on the $260,000.  However, when he pulls the $40,000 out of redraw for the new property, the home loan balance reverts back to $300,000, but only $260,000 remains as tax deductible debt. This is essentially because Stephen has re-borrowed $40,000, and the purpose of that $40,000 is for his own home, which is a non-tax deductible expense. Therefore Stephen has forever apportioned this home loan to  be 86% tax deductible and 14% non tax deductible. There is no way to clean this
mess up as the damage is done! Stephen will never be able to claim that $40,000 as tax deductible. That is a $2,720 tax offset per annum for as long as he holds that investment. 

If Stephens top marginal tax rate is 30c in the dollar, then that tax offset is a savings of $816 per annum. Let’s say he holds that property for 10 years. That’s a savings of $8,160, net. See how this small oversight could be costing you
thousands?

Be aware

100% offset accounts typically only work when linked to variable rate home loans, so please keep this in mind and check with your lender. All lender offset accounts can differ, for example, the CBA’s offset account, named a MISA (Mortgage Interest Saver Account) has a minimum $500 transfer in or out of the account, whereas ANZ’s offset, the ANZ ONE is a fully transactional account where you can direct your paymaster to. Check your loan’s offset account features and methods of operation with your lender or broker in full to ensure you have a good handle on how to set things  up.

In closing, offset, not redraw.

 Just last week I refinanced a loan for a client who had paid $300k extra off into his investment home loan directly, rather than the offset. He’s now redrawing that cash for personal purposes. What a shame, that had he used an offset account, all that debt would be a tax deduction again. He stands to lose a lot more, as he’s in a higher marginal tax rate, and will be holding this property for a lot longer. 

Even if you’re unsure about how you’re going to use the property later, it doesn’t cost extra to use your offset account instead, so take this small precaution, and reap the benefits later.