Loan Interest Offset Accounts
A loan offset account is simply a savings account linked to your loan account. An offset account works like a regular savings/transaction account. The big difference is that the balance in the savings account is offset against that owing on the mortgage. Any ‘notional’ interest on savings is earned at the same rate as the linked loan interest rate.
Over time, savings in your offset account can help to reduce the loan principal, allowing you to pay off your loan sooner or build up equity.
We believe the proper use of Interest offset accounts is strongly encouraged. These accounts allow you to in effect, earn the home loan interest rate on your savings, tax free, rather than the much lower and taxable deposit rate whilst retain full accessibility when those funds may be needed.
For example, with a 5% non-deductible home loan of $100,000 and a 1.5% bank account of $20,000 you should transfer the $20,000 to an interest offset account. If you do this you are in effect swapping a taxable 1.5% for a non-taxable 5% on your $20,000.
That is, at an effective marginal tax rate of 49%, you are going from an after tax earnings rate of 0.765% (i.e. 1.5% less 49% tax) to an effective pre-tax interest rate of 9.8%.
What about interest offset accounts on investment loans?
Interest offset accounts on investment loans are useful, but should only be used once all non-deductible debt has been re-paid.
If you have an interest offset account on an investment loan and a non-deductible debt you should withdraw the monies and either pay off the non-deductible debt or deposit the monies into an interest offset account linked to the non-deductible debt.
The only effective way to reduce debt is to pay more or make more frequent repayments towards your debts. This has the cumulative effect of reducing the interest costs accrued to those debts and thus reducing the amount of the principal debt being repaid with each repayment.
Managing your cash flow and utilising any surplus funds or disposable income and appropriating that surplus to the correct order of debt repayments is the foundation of your Cascade Debt Reduction plan.
How a full interest offset account works:
Each day when funds are held in an offset, the balance is linked against and reduces the amount you owe on your home loan when calculating interest.
Interest is calculated daily and charged monthly only on the net amount (your loan balance less your offset account balance for that day).
Funds held in your offset account are readily available and can be withdrawn at any time.
Unlike a savings account that earns interest (which you must declare to the ATO and pay tax on), you earn no interest on the balance in your offset linked transaction accounts. Instead full interest offset reduces the amount of interest charged on your home loan balance.
The result is you don't pay tax on interest you haven't earned and the interest payable on your home loan is reduced
If your home loan balance is $350,000 on a particular day and your linked savings account balance is $50,000 on that day, as interest is calculated daily you only pay interest on $300,000 for the day. You will not earn interest on the $50,000 in your offset account, instead the $50,000 is offsetting the interest charged on your home loan. As your offset account is reducing the interest charged on your home loan, but your standard repayments remain the same (reflecting the loan balance of $350,000), more money will be attributed to the principle and will in affect help you own your home sooner.
Note: Lenders may apply and annual or monthly fee to having an Offset facility linked to your home loan. Enquiry with your Credit Adviser about this.
Using an offset account properly can save you thousands over the life of your home loan and slash years off your mortgage. Once you get into the habit of organising your finances in this way, you will never look back.