When you go to a bank to get your loan, they’ll often outline two different types of mortgage for you to choose from.
These are Redraw loans and Offset accounts. The banks usually don’t discuss mortgage reduction, but describe these loans to you something like this:
A redraw facility allows you to make extra payments on your home loan and then access this money again when you need it.
By paying off a greater amount of the loan you save money, as no interest is charged on the amount already repaid, and with a redraw facility you have the security of knowing you can access the money if need be.
A redraw facility can be a useful way of helping you reduce the interest on your loan, but how useful it is will be determined by the specific plan that the lender offers.
An offset account is, simply, a savings account that is connected to your home loan. The money you place in this account counts towards your mortgage, and therefore reduces the amount of interest that you have to pay. The offset account also functions like a normal savings account, with the money being accessible by ATM and EFTPOS.
A 100% offset account means that the same interest is earned in the savings account as is paid in the mortgage account, whereas a partial offset account means that a lower interest is earned than is paid. So, a 100% offset account is usually a better deal, although many banks will offer them only with certain loans.
Okay, all good so far. However, with so many of the clients I’ve met over the years, the banks don’t tell them what will happen if they convert the property they are buying into an investment property and attempt to have the loan classified as an investment loan by the tax office. And this is where the two loans can be vastly different.
This is because the tax office will only allow an existing loan to carry forward as the tax deductible facility when you convert the property to an investment property. Therefore, if you’ve paid down the Redraw loan to a lower level, the tax office will only allow the lower level to apply as a tax deduction on the investment – they won’t allow the amount that you redraw to increase the loan back to its original level.
So, if you are intending to raise the level of borrowings to the original loan level at the time you took it out and use the redrawn funds as a deposit on your new home, you won’t be able to claim the higher loan amount as tax deductible.
On the other hand, if you use an Offset account, when you draw the money from your savings account as the deposit on your new home, the original loan remains fully deductible. This is because the original loan never changed. It was never reduced by the extra payments you made because these simply went into a savings account the bank had set up for you. The tax office is therefore happy to allow the full amount of the interest payment on the original mortgage as tax-deductible costs against the property when it become an investment asset.
When you model the difference between these two outcomes the benefits to the home owner of the Offset account over the Redraw facility can be very substantial in terms of mortgage reduction and can run into tens and maybe even hundreds of thousands of dollars in improvement of the investment returns.
The lesson here is that you should work with your financial adviser to establish a detailed and well-articulated financial plan as soon as possible. That way, everything you do now is harmonized with what you intend to do later.
Speak to your financial adviser or your tax accountant today and have them explain how Offset accounts might work for you.
If you want to know more about mortgage reduction, you can call us Superannuation in Australia Today on 1300 742 828. We are always there for you.
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