Combining an interest-only loan with an offset account lets you offset your taxable income and minimise your costs. It's a good strategy for anyone who wants to turn their home into an investment later.
An interest-only home loan with an offset account offers a doubly effective tax strategy for property investors. It works like this: An interest-only loan minimises your loan repayments in the short term because you only pay off interest. And as an investor, these interest payments are tax deductible.
But your actual debt doesn't go anywhere. If you put money into an offset account attached to the loan, you can effectively build up your savings as if you were repaying the loan. But you can use this money as you need, which offers greater flexibility. And because you're not actually paying the loan principal off, your loan repayments are tax deductible.
A home loan offset account works like a bank account. You can save money in it, and spend if you need to. Every dollar in your offset reduces the interest payable on your mortgage by the amount held in the account.
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.
Opening an offset account on an interest-only loan has several benefits for investors, including:
Let's say you want to upgrade your home, so you buy a new place. But then you decide you want to keep the old place as an investment property.
This is easy to do. But if you've repaid most of the loan on your original house, you've actually reduced your tax benefits as an investor.
Why? Because as a home owner, lower debt is good. But as an investor, interest charged on debt is tax-deductible. You want a smaller debt on the house you live in and a bigger one on the investment.
Here's an example:
Andrew lives in an apartment. He has a $450,000 mortgage, and he's made repayments over the last few years. He now has $250,000 left on the loan.
Andrew decided to buy a new place but keep his old unit as an investment. To cover part of the new home purchase he pulls some money out of the original loan. His original loan turns into an investment loan.
Interest charges on Andrew's investment loan (the old property) are now tax deductible. But because he repaid so much of the loan (rather than putting it in an offset) the tax deductible amount is only the remaining $250,000.
As a result, Andrew has minimised his tax deductible debt and increased his non-deductible debt which is not a good tax outcome.
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 have 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 converted his property into an investment, Andrew could have withdrawn funds from his offset account and use the funds as a deposit for his next property purchase. Then his investment loan debt would be bigger, and thus his tax-deductible debt would be bigger.
| Response | |
|---|---|
| Yes | 62.69% |
| No | 37.31% |
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.
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I plan to buy a home unit as a second place of residence. As I dont plan to rent it out, is this an investment loan still?
I would be looking to borrow only about 10% of the value of unit but would like the option to increase this later as a I expect a large tax bill in 2023. I think about 500,000 total with mortgage on a 2million plus unit.
I currently have a line of credit type loan which I have drawn down to zero. I could just use this but the interest rate is 5.25%.
Hi Rick,
If the property is not your principal place of residence then the loan may still be treated as an investment loan regardless of whether you rent it out or not. It’s best to clarify this with a lender or broker before applying for a loan.
An investment loan interest rate will likely still be lower than your 5.25% line of credit rate. Also, if you increase your investment loan amount later then it is harder to get tax benefits.
In a complicated situation like this, getting in touch with a mortgage broker is a good idea.
Cheers,
Sarah
Hi,
With the offset account how much would be recommended amount to deposit, to how much you have borrowed.
Regards
Hi Graeme,
Thanks for reaching out.
Typically, the more money you deposit in your offset account, the more you could save on interest payments for your home loan, which will likely make your home loan term shorter. Say for example, 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.
I recommend getting in touch with a licensed mortgage broker. A broker can help you understand your financial position and they can leverage their panel of networks to find a lender that’s more inclined to review your application. You may also consider speaking with an accountantto make sure you understand the tax implications involved.
Thanks,
Belinda
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
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.
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.
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