Understanding Offset Accounts

This is a question that I see all the time, with people wanting to understand the difference between using an offset account, vs paying extra funds straight into their loan account. 

Essentially, an offset account is a separate account, which is linked to your loan account. 

We will use as an example you owe $500,000 and have $100,000 cash. You put this cash into your offset account, and will now only be charged interest on $400,000 (your $500,000 on a balance less the $100,000 offset).

The alternative is paying directly into your loan account. This will lower your loan balance down to $400,000, so again, paying interest only on that amount.

So, if you're paying the same amount of interest, what difference does it make?

With an offset account, your loan balance remains unchanged, yet you will pay interest on the value of your loan less the offset account balance. Paying directly into your loan, you will reduce the balance of your loan.

Assuming you will only ever use your home and therefore mortgage for personal reasons, and if you change over your home at some point you sell your current home, it probably doesn't matter. However, this can become an issue (and is quite a common scenario) where you buy a new home, and instead of selling, convert your existing home into a rental property.

In this situation, the ATO is of the view that when you used the $100,000 to pay down the balance of your loan, you repaid the original borrowings.  If you were to then redraw the $100,000 back out of your loan, this is new borrowings, and you would need to determine the purpose of those new borrowings. If the purpose is to pay a deposit on your new home, then that $100,000 will not be tax deductible against your now investment property, meaning you will only be able to claim interest on the $400,000.

However, had you kept the loan balance at $500,000 with the $100,000 in an offset account, you can use that $100,000 for whatever purpose you like and the original $500,000 loan will remain fully tax deductible.

Some things to consider, however, are:

• Some banks will charge a higher interest rate to have a loan with offset facility;

• You should ensure that if you do pay funds down directly into your loan, that you have redraw access;

• If you pay down the balance of your loan, your loan repayments will not usually change, meaning you will still be required to make repayments based on your original borrowings.

This is general advice only - if you would like to discuss what this means for your personal circumstances, please book a call with me today.