It’s no surprise that astute property investors are always looking to find ways of making their money work as hard as possible. In fact, most sophisticated property investors have either a high level of financial literacy themselves, or they make sure they leverage the expertise of their professional A-Team to get their desired outcomes.
In terms of financial literacy, a well-known rule for property investors is that personal debt should be paid before investment debt. In other words, your home loan, credit cards, personal/car loans etc, need to be the focus of your debt reduction efforts for tax efficiency, before looking at allocating extra funds to paying down the principal of investment loans.
But what about the thousands of property investors who don’t have any personal debt? Should they be paying down the principal of their investment mortgage? Surprisingly, in many cases the answer could be NO.
Instead these property investors could consider using a mortgage offset account, which when used correctly, is a powerful financial tool.
Now firstly, it needs to be understood that unlike a redraw facility, a mortgage offset account isn’t part of your investment loan. Rather, it’s more like a separate transactional savings account. However instead of earning interest, this account ‘offsets’ the interest on the loan that it is linked to.
Here’s an example of a full offset account linked to an investment loan for property investors with no personal debt:
Imagine you buy an investment property and have a loan of $400K (with a full mortgage offset account).
You have surplus cash savings of $50K, which you place into that offset account.
The lender will subtract this $50K from the loan balance and only charge you interest on the balance, which is $350K.
So, why is this a good outcome?
- It’s very likely that the interest rate in the savings account where the $50K cash savings was originally sitting is much lower than the interest rate being offset on the investment loan
- The interest earned in the savings account where the $50K was originally deposited is taxable, whereas the interest being offset against the investment loan is not
But isn’t there something called a mortgage redraw facility that gets the same result as an offset account for property investors?
Well, technically, yes, it is possible to get the same outcome from a redraw facility, however it lacks the same convenience as an offset account and with investment loans it carries with it some risk (more on this later).
A redraw facility is a feature available on many home loans, where the borrower can withdraw funds already made to pay down the principal of the loan. But there are reasons why this facility may not be as convenient as an offset account:
- Some lenders set minimum re-draw amounts and charge a separate fee for each re-draw
- Some lenders can make you wait a few days before they will give you access to funds
- Redraw facilities often lack the fully transactional characteristics of offset accounts (eg Bpay)
There is an argument that not having at call access to funds in re-draw (as opposed to an offset account) imposes a protective discipline on property investors, however this benefit is offset (pun intended) by a bigger problem.
Any funds withdrawn from an investment loan redraw facility for personal use can ‘contaminate’ the loan. This means the ATO can deny interest deductions or impose limitations on the interest deduction claims for the life of the loan.
An example of this is if you withdrew $20K from your investment loan redraw to buy a car. If the loan was $400K, then it’s likely that the ATO would now deem this investment loan to be only 95% tax deductible, for the life of the loan.
This loan deductibility issue does not happen if you use an offset account on an investment loan, because the offset account is a separate facility to your loan.
You could withdraw as much as you like from the offset account for personal use and the loan will still be 100% tax deductible.
This is why many accountants encourage property investors to use offset accounts.
Here’s another common scenario. Just say you are moving to a new home (ie Principal Place of Residence or PPOR), but wish to keep your existing home as an investment property.
Normally you would have been paying your home loan down, so when you upgrade to your next home (PPOR), your new home loan is likely to be a lot larger than the existing loan you’ve been paying down (which is now classified as an investment).
If this happens, your loans become ‘upside down’, meaning you end up with a large personal debt on your new home loan, and a smaller tax-deductible investment debt on the original home.
This is not a good outcome for most property investors.
So, if keeping your existing home as an investment property is your intention, then you could consider discussing this strategy with your financial adviser:
- Set up an interest only loan for your PPOR with a 100% offset account attached
- Instead of paying down any principal on this loan, you would direct all your income and savings into the offset account
- When you find your new home, you would use these funds in this offset account to minimise the debt on the new home and maximise (the now tax deductible) interest payments on the original home loan
There are pros and cons to doing this, and some lenders are offering better interest rates on P&I loans – and will indeed only lend on this basis at the moment. Every borrower has different circumstances and you MUST consult with your finance and mortgage professional before deciding on the right loan products for yourself. They can advise you on the best path to take.
These are just a couple of common scenarios, however there are even more reasons we could add as to why a 100% mortgage offset account can be such an effective financial platform for property investors.
If you need help with this or anything else property related, why not get in touch? Over the years our QPIA advisers have helped hundreds of property investors make the right choice, so simply call us on 1300 077 766 or email firstname.lastname@example.org
The information provided in this article is general in nature only. It has been prepared without taking into account your objectives, financial situation or needs, and should be in no way deemed as personal financial or financial product advice. Before acting on this information you should consider its appropriateness, having regard to your own objectives, financial situation and circumstances.