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
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.