How intelligent investors take advantage of offset accounts and interest-only loans

Rates and Fees verified correct on December 9th, 2016

Property investors can reap significant tax benefits by taking out an interest-only loan with an offset account. Find out how you can apply this strategy.

How investors can benefit from interest only loans and offset accounts

Interest-only home loans with an offset facility can be attractive for investors as they allow you to reduce your monthly repayments, minimise your non-deductible debt (and increase your deductible debt), and secure a good return (capital gain) if you purchase a principal place of residence (PPR) and then convert your home into an investment property.

While some borrowers may be swayed by the draw cards of a principal and interest loan, taking out an interest-only loan with an offset account is an effective tax strategy if you have the financial discipline to make regular extra repayments into the offset account as it can reduce the amount of interest payable on your mortgage.

For many, opting for an interest-only mortgage with an offset account requires a shift in attitude and gaining sound knowledge about the financial benefits of this structure. It’s also strongly advised that you seek advice from a savvy mortgage broker and a tax accountant to make sure you understand the tax implications involved.

How does an interest-only loan with an offset work?

If you want to minimise your taxable income and lower your monthly repayments, then you may want to set up an interest-only home loan with a linked offset account.

An offset account works in a similar way to a transaction account; however, it reduces the interest payable on your mortgage by the amount held in the account. That is, the account effectively reduces or offsets the amount of interest you pay on your home loan.

For instance, if you had a mortgage of $450,000 and you had $25,000 in your offset account, you would only owe the bank $425,000. When the lender calculates your daily interest, you’d only be charged on the $425,000 owing, instead of the $450,000.

With an interest-only loan, you will only pay the interest portion of the loan and thus your periodic repayments will be lower compared to a principal and interest loan. When you make extra repayments into the linked offset account, this gives you increased flexibility with your finance strategy. Maintaining your savings in an offset account acts as a safety net should your situation change in future, such as if you wanted to purchase an investment property.

What are the benefits of using an offset account on an interest-only loan?

Opening an offset account on an interest-only loan has several benefits for investors, including:

  • Lower repayments. As mentioned above, as you will only be paying the interest portion of the loan, your periodic repayments will be lower, freeing up your cash for other investments.
  • Tax deduction. You can claim a tax deduction for interest paid on your property if it is clear that the purpose of the loan is for investment. To claim the interest as a tax deduction, you should focus on reducing the interest payable on the non-deductible debt.
  • Separation of debt. With an interest-only home loan, you can keep the original debt separate. You can then put savings into an offset account against any debt that’s not tax deductible. This means you can move your savings to whichever debt is not tax deductible, which helps separate your debt.
  • Contingency buffer. An interest-only mortgage with an offset facility effectively provides you with a contingency buffer to cover unexpected costs or a lifestyle change.

Turning your home into an investment property

It’s likely that the first home you buy may not be the ultimate principal place of residence (PPR), and thus you may decide to turn your PPR into an investment property.

The Australian Taxation Office (ATO) states that once you pay off your debt, you can’t withdraw on the debt to get a tax deduction unless it’s for investment reasons. If you moved out of a house and decided to convert it into an investment, the tax deductible amount will be lower compared to the original loan amount.

If there’s a possibility that you may turn your existing home into an investment, then having an interest-only home loan and making extra repayments into an offset account can be useful. This is because you are effectively building up a cash buffer which you can use in the future to help purchase another property.

As you may not have fully repaid your existing mortgage, this will allow you to reap the benefits of higher tax deductions on this debt.

Buying a home in the future

It’s likely that you may purchase another home in the future and this debt will be non-deductible as it’s your primary place of residence. If you’re thinking of buying a home in the future, you’ll need cash or equity to cover the deposit (as a bare minimum). If you have this cash sitting in an offset account, you can access it as you need it and also get the tax benefit.

If there’s a chance that you may purchase a residential property in the future, you want to ensure that you have as little interest payable as possible as it will be non-deductible. You should therefore work towards building up your savings in an offset account as you can use this towards buying a home further down the track. This allows you to minimise your non-deductible debt while maintaining the same level of tax-deductible debt.

How can I go about setting up this structure?

Before you take out an interest-only loan with an offset account, you need to work with a savvy mortgage broker, financial planner or tax specialist to evaluate your financial position. Identify the amount that you can afford to put into the offset account each month and discuss your investment strategy with them to see whether this structure will allow you to meet your investment goals.

If you make additional repayments during the interest-only period, and you can cover the extra repayments when the loan reverts back to principal and interest, then an interest-only loan with an offset could be a good structure to consider.

NAB Choice Package Variable Rate Home Loan - $250k to $749,999 Interest Only (Owner Occupier)

NAB Choice Package Variable Rate Home Loan - $250k to $749,999 Interest Only (Owner Occupier)

4 .50 % p.a.

variable rate

4 .80 % p.a.

comparison rate

Home Loan with Offset Account Offer

With the NAB Choice Package Variable Home Loan (Interest Only) you can make interest only payments for up to 5 years, and enjoy a 100% offset account.

  • Interest Rate of 4.50% p.a.
  • Comparison Rate of 4.80% p.a.
  • Application Fee of $0
  • Maximum LVR: 95%
  • Minimum Borrowing: $250,001
  • Maximum Borrowing: $749,999

Compare interest only home loans with offset accounts

Rates last updated December 9th, 2016
$
Loan purpose
Offset account
Loan type
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Interest Rate (p.a.) Comp Rate^ (p.a.) Application Fee Ongoing Fees Max LVR Monthly Payment
NAB Choice Package Variable Rate Home Loan - $750k+ Interest Only (Investor)
Borrow up to 95% LVR with a redraw facility and no application fee.
4.60% 4.90% $0 $395 p.a. 90% Go to site More info
NAB Choice Package Variable Rate Home Loan - $250k to $749,999 Interest Only (Investor)
Borrow up to 95% LVR with a redraw facility and no application fee.
4.65% 4.95% $0 $395 p.a. 90% Go to site More info
NAB Choice Package Variable Rate Home Loan - Up to $250k Interest Only (Investor)
Borrow up to 95% LVR with a redraw facility and no application fee.
4.90% 5.19% $0 $395 p.a. 90% Go to site More info
NAB Base Variable Rate Home Loan - Investor (Interest Only)
A home loan with no ongoing fee and a redraw facility that you can borrow up to 90% LVR.
4.78% 4.50% $0 $0 p.a. 95% Go to site More info
NAB Tailored Home Loan - Investor (Interest Only)
Enjoy a 100% offset account with a low ongoing fee and pay no application fee for a limited lime.
5.50% 5.56% $0 $8 monthly ($96 p.a.) 90% Go to site More info
UBank UHomeLoan Variable Rate - Standard Variable Rate (Investor with Investor Offer Interest Only)
Pay interest only repayments with this special offer for investors.
4.24% 4.24% $0 $0 p.a. 80% Go to site More info
Switzer Investment Loan
An investment loan with no application or ongoing fees, and your very own lending service manager.
4.09% 4.09% $0 $0 p.a. 80% Go to site More info
UBank UHomeLoan - 3 Year Fixed Rate (Investor)
Pay no ongoing fees on this investment loan fixed for 3 years.
3.69% 4.21% $395 $0 p.a. 80% Go to site More info
3.99% 3.99% $0 $395 p.a. 0% More info
St.George Fixed Super Fund Home Loan - 3 Year Fixed Rate (Investor, IO)
A competitive 3 year rate which can be used to purchase property through an SMSF.
5.09% 5.70% $1,500 $12 monthly ($144 p.a.) 70% More info
5.37% 5.45% $495 $0 p.a. 95% More info
CUA Fresh Start Basic Variable Home Loan - Investor
Enjoy a competitive rate with no ongoing fees, flexible repayments and free redraw facility.
4.39% 4.44% $600 $0 p.a. 90% More info
AMP Basic Package Variable Rate Loan - Investors
A basic package loan with a competitive rate and no ongoing fee.
4.06% 4.10% $350 $0 p.a. 90% More info
4.09% 4.50% $0 $395 p.a. 80% More info
3.94% 4.35% $0 $0 p.a. 85% More info
St.George Portfolio Home Loan With Advantage Package - $250K to $499K (Special Discount)
Enjoy the flexibility of an equity loan when building your home.
4.84% $0 $395 p.a. 90% More info
Westpac Rocket Investment Loan - Interest Only
Use Westpac's variable home loan to purchase your next investment property.
5.60% 5.74% $600 $8 monthly ($96 p.a.) 95% More info
Queenslanders Credit Union Interest Only Home Loan - < 250k
Borrow up to $249999 loan amount. $1,000 cash back available when refinancing. Terms and conditions apply.
4.84% 4.78% $595 $100 p.a. 95% More info
Queenslanders Credit Union Interest Only Home Loan - > 250k
Borrow from $250000 loan amounts. $1,000 cash back available when refinancing. Terms and conditions apply.
4.61% 4.53% $595 $100 p.a. 95% More info

Principal and interest vs. interest-only with an offset

Case study interest only loans and offset accountsAndrew purchased a two-bedroom apartment in Victoria (VIC) and took out a $450,000 mortgage to finance the residential purchase. The loan was set up as principal and interest (P&I) and Andrew worked to pay off his debt as soon as possible.

It’s six years on and Andrew has managed to get his loan down to $250,000. However, Andrew has now decided that he would like to buy a bigger house, and maintain his two-bedroom apartment as an investment property.

As Andrew has $250,000 owing, when the property becomes an investment, he can only claim interest on a $250,000 loan even though the property value has appreciated over time, and is now worth around $600,000.

Andrew wanted to use the equity from his first property to help purchase his next one. However, the equity that he can access from his two-bedroom apartment won’t be tax deductible because it’s being used to purchase a primary place of residence (PPR).

As a result, Andrew has minimised his tax deductible debt and increased his non-deductible debt which is not a good tax outcome.

What’s the solution?

If Andrew had taken out an interest-only mortgage with an offset account, he could have resolved this problem.

Instead of paying down the principal portion of the loan, Andrew could put his additional savings (that would otherwise be principal repayments) into the offset account. This would have helped Andrew minimise the interest payable on the outstanding loan amount.

When he converts his property into an investment, Andrew could withdraw funds from his offset account and use the funds as a deposit for his next property purchase. Instead, Andrew would have increased his deductible debt and minimised his non-deductible debt.

What should I keep in mind when pursuing this strategy?

    • Expert advice. Seek independent tax advice before taking out an interest-only loan with an offset facility. Speak to a mortgage broker regarding your investment strategy and the structure of your home loan to ensure that this is the right option for you.
    • Regular extra repayments. For this strategy to work, you need to make sure that you’re making regular additional repayments into the offset account. If you don’t have this financial discipline, then this structure may not be right for you.
    • Don’t withdraw from offset. If you use an offset account with your interest-only mortgage, make sure you won’t be tempted to withdraw from the account as this can work against your investment strategy.

Belinda Punshon

Belinda is a journalist here at finder.com.au. Specialising in the home loans and property sections, she is passionate about helping Australians improve their financial wellbeing.

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6 Responses to How intelligent investors take advantage of offset accounts and interest-only loans

  1. Default Gravatar
    Graeme | April 12, 2016

    Hi,

    With the offset account how much would be recommended amount to deposit, to how much you have borrowed.

    Regards

    • Staff
      Belinda | April 12, 2016

      Hi Graeme,

      Thanks for reaching out.

      finder.com.au is an online comparison service so we are not licensed to give you personal advice regarding the amount of funds you should put in an offset account. If you need advice about how to structure your loan or how to use an offset account, please get in touch with a mortgage broker or a tax accountant.

      Thanks,
      Belinda

  2. Default Gravatar
    Dean | March 5, 2016

    Hi,

    From what I have seen, most Interest only loans run for 5yrs.
    So assuming you take a 5yr interest only loan do you then have to refinance every 5 years to keep it interest only or are there lenders that offer longer periods?

    Cheers

    • Staff
      Marc | March 7, 2016

      Hi Dean,
      thanks for the question.

      In recent years interest only options for many loans have been reduced to 5 years. In the past some lenders offered 10 – 15 year terms.

      This means that today, borrowers wanting to make interest only payments for longer than 5 years will have to consult their lender to see if they can get another interest only term, or consider refinancing.

      I hope this helps,
      Marc.

  3. Default Gravatar
    ALEX | February 29, 2016

    Hello,

    From what I’ve seen ‘interest only loan’ interest rates are slightly higher than ‘principal and interest loans’.

    As an example a ‘principal and interest loan’ will have the rate of 4%. A portion (lets say 3%) is the interest payment and a portion (the remaining 1%) pays down the debt.

    While the ‘interest only loan’ will have a rate of 4.5%. Where 4.5% is the interest payment with nothing going toward paying down the debt unless you make additional payments.

    If the borrowers main objective is to pay down the debt as quickly as possible can you please explain why a ‘principal and interest loan’ wouldn’t be better than an ‘interest only loan’ with or without an offset account.

    Thanks
    Alex

    PS: It would be great if you could email me your response as well as publishing it for others.

    • Staff
      Belinda | March 1, 2016

      Hi Alex,

      That’s a great question.

      Every borrower faces the decision to opt for a principal and interest or an interest-only loan and the suitability of each depends on your financial discipline and your investment objective.

      The premise of this article is to explore how investors can benefit from using an interest-only home loan with an offset account. The strategy is that some investors can increase their tax-deductible debt by only paying the interest portion of a home loan (this would not be achieved to the same extent with a principal and interest loan, although you make a valid point about a potentially higher interest rate with an interest-only loan, but this depends on the product and the lender).

      By making regular deposits into an offset account with an interest-only loan, investors can focus on reducing the interest payable and benefit from significant tax savings. This is especially true if you decide to move out of your principal place of residence (PPR) and convert it into an investment property later on.

      If you need personal advice, please get in touch with a tax specialist.

      Kind regards,
      Belinda

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