Loan offset account could help you to save up to tens of thousands of dollars on tax or interest. Below are the two main reasons.
Reason 1: Offset account could help you to save $$$ on tax
Firstly, what is an offset account? An offset account is linked to your residential loan account. It can be used as any saving account. But the balance of an offset account can be used to offset the loan balance, and you only need to pay interest on the difference.
For an example, if your loan balance is $500,000, you have $200,000 in your offset account, you only pay interest on the difference of $300,000.
Some banks do offer redraw facility to you on your loan, where when you overpay your loan, you can redraw the overpaid amount any time. So, what is the major difference between the two choices?
- If you had an offset account for a rental property, you could spend the money in your offset account for other private purposes, and still claim the interest on the full balance as deduction to reduce rental income. For an example, if you spend $50,000 from the offset account to purchase a private car, you can claim the interest on the loan balance of $350,000 ($500,000 minus $150,000).
- If you didn’t have an offset account and paid the $200,000 directly to the loan account, your loan account balance will be changed to $300,000. At this point tax office will only allow you to claim interest on this $300,000. If you redraw $50,000 to purchase a car for private purpose, tax office will not allow you the deduction on the extra interest incurred on this redraw (due to private purpose). So the interest deductions will be fixed on the $300,000 only.
This could be more important when you are changing the purpose of your own residential property. For an example, a couple brought a property at $1,000,000 with a $800,000 loan. They worked really hard for 5 years and paid all their income directly back to their loan account. At this point they only had $200,000 left in the loan. Now they want to purchase another property to live in, and change this property to an investment property. Unfortunately, now they can only claim the interest on the $200,000 as deductible. If they redraw any amount from the loan account to pay for the down payment on the new property, it will be treated as ‘private purpose expense’ and not deductible based on tax law requirements.
Reason 2: Offset account could help you to save your interest
The beauty of an offset account is, as soon as you have the money there, for as long as it can be, it will help you to save interest. At the same time, you can use it almost like any other saving account. The only limitation is you can only have an offset account for a variable loan. In the current environment, some people might feel that they prefer a fixed rate loan versus standard variable. The best tactic might be a combination of both. For an example, if you have a loan balance of $500,000, if you are confident that you can pay off $200,000 in 3 years, maybe you can split the loan to 2 parts: $200,000 in standard variable, and $300,000 in fixed rate. For the variable loan, you can set up an offset account ant try to save as much as possible to this account. In this way, not only you can reduce the balance of the loan as quickly as possible, but you are also securing the fixed rate for part of the loan. Of course there is another possible add-on benefit: since we never know which direction the interest rate will move. What if you have fixed the interest rate to 5% for 3 years, then 2 years later the interest rate drops to 3%? By having part of your loan variable, you can still partially benefit from this interest cut.
As you might already know, Australian tax system is very complicated. This is only a top-level advice. Before you make any major investment decisions, such as buying or selling a property, investing on share market or cryptocurrency, you need to talk to an experienced tax agent to help you to understand related tax law requirements. This can potentially save you up to tens of thousands of dollars by avoiding some of the common mistakes and utilizing all possible tax planning opportunities.
P.S.: We have a free mortgage calculator on our website that will help you to calculate how much you will need to pay per month up to the end of the full term of the loan. You can also vary the interest rate and payment amount to see how soon you can pay if off under different scenarios. You can find it here: Impact Taxation Mortgage Calculator. Should you have any questions with it please don’t hesitate to let us know.
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