I found this great article I would like to share with you regarding one benefit of a Mortgage Offset Account over a line of credit. It is from respected financial commentator Noel Whittaker:
“Column by Noel Whittaker”
“Last week I talked about tax deductibility of interest. Today we will take it a step further and think about strategies for borrowers who are using line of credit loans.
There is confusion about home loan accounts with a redraw facility and offset accounts. It’s worth taking the time to understand them because they are vastly different animals and getting it wrong can be very costly.
An offset account is simply a savings account with the interest being deducted from your loan interest instead of being paid to you as taxable income. At any stage, funds can be withdrawn from the offset account without tax implications.
In contrast, every time you make a withdrawal from a line of credit account, you are establishing a new loan.
Suppose a couple have a $400,000 loan on their home and have the goal of eventually upgrading to another home and renting the original out. Over the years they have accumulated $350,000 in their offset account, which means they effectively owe only $50,000 on their property. When they make the move they simply withdraw the $350,000 from the offset account and use that as a deposit on the new home. This leaves them with a $400,000 debt on the now tenanted original property and they can claim all the interest on it as a tax deduction.
Their neighbours once had a $400,000 loan but have worked hard to reduce the debt to $50,000. If they move out, the debt on the now rented property will be stuck at $50,000. Certainly they could redraw funds from the original loan to buy their dream home but the interest will not be tax deductible. They will have a huge non-deductible debt on their new residence, and will be paying tax on the rents from the original property.
An investment line of credit loan can be a particular trap if the borrowers do not keep their business and private expenses strictly separate. Unfortunately far too many borrowers deposit their salary into the investment loan account and then withdraw funds each month for normal living expenses. They do not realise that the deposit of the salary is treated by the tax office as a permanent reduction of the debt, and each redraw is a new loan. Because the redraws are used for a private purpose such as paying for groceries, the loan very quickly loses its tax deductibility. The lesson in all this is that you should keep your investment and private borrowings separate and always use an offset account if you intend to rent out a property that is presently used as your own residence.”
The author Noel Whittaker is a director of Whittaker Macnaught, a division of St Andrew’s Australia. This advice is general in nature and Readers should seek their own expert advice before making financial decisions. Noel’s e-mail address is [email protected]
“if you want to pay off your mortgage sooner, a home loan with an offset facility can be a quick and simple option.
A mortgage offset account is simply a savings account linked to your loan account. Unlike an all-in-one loan that combines your credit card with your transaction accounts, an offset account works like a regular savings 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.
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.
Types of offset accounts
There are two different types of offset accounts – a 100 per cent offset and a partial offset account. As the benefits of offset accounts have become more widely understood, most lenders and borrowers opt for a 100 per cent offset facility.
John and Betty have a $100,000 mortgage and $10,000 in a linked 100 per cent offset account.
* The principal on a $100,000 loan is reduced by the $10,000 offset account to $90,000.
* As a result interest only accumulates on the $90,000 balance of the loan.
* Repayments continue to be made on the entire $100,000 principal and applicable interest.
* While savings in the offset account are actively working to reduce the loan, repayments are working more effectively to reduce both the principal and interest it attracts
* Over a number of years, both the principal and interest on your loan are repaid faster.”
This advert from a bank also helps with the explanation.