The recent rise in interest rates has many people looking closely at their home loan. Whether you are thinking about switching lenders or not, the interest rate should NOT be your only consideration. Using an offset account offered by your lender, can also reduce the amount of interest you’ll pay.
In this article, we introduce you to Jenny (not her real name), an executive whose financial plan included a home loan repayment strategy that enabled her to reduce the interest on her home loan, use the cash she’d accumulated to purchase an investment property AND benefit from a significant tax saving.
Before I introduce you to Jenny, it’s important to understand the difference between an offset account and a redraw facility – both commonly offered by lenders.
The simplest definition is this…A home loan redraw facility forms part of a home loan agreement, while an offset account is a separate savings account that is linked to the home loan.
Both provide opportunity for making additional loan repayments that contribute to reducing the interest on the loan balance and therefore help to pay the loan faster. Both options also provide opportunity to access the extra cash should you need it for other purposes.
However, withdrawing funds using a redraw facility can be subject to conditions set by the lender, and these may limit the amount of funds you can access (sometimes denying your request completely) and redraw fees can apply.
Conversely, no such limitations affect an offset account. This is because an offset account is a separate saving account owned by you, approved by your lender and linked to your home loan. Any cash deposited into this saving account ‘offsets’ the balance of your loan account, which reduces the amount of interest charged.
With this in mind, here’s Jenny’s story.
Jenny is a successful tech firm executive who recently accepted a promotion to Chief Financial Officer. This meant she needed to relocate from Brisbane to the firm’s Melbourne head office.
Jenny, keen to get a foothold in the property market, had purchased a home in Brisbane a few years prior and was repaying a $500,000 home loan. Her earnings were such that she was able to meet the repayments easily and she had made extra repayments which had grown to $100,000 in her offset account.
Jenny wanted to rent her Brisbane property and benefit from the additional income and any tax-deductible expenses (including interest). She withdrew the $100,000 she had accumulated in her offset savings account and put it towards a deposit on a studio apartment – her new home in Melbourne.
This meant her Brisbane home loan reverted to $500,000 and because this home was now a rental property, the ATO considered the interest tax deductible on the entire $500,000 loan.
With the rental property loan separate from her studio loan, Jenny concentrated on paying down her non-deductible studio loan, while the rental income and tax-deductible interest and expenses on the rental property met the repayment commitments on her Brisbane rental property loan.
If Jenny had opted to accumulate her $100,000 in extra repayments in a home loan redraw facility, her situation would have been very different because that money would have been ‘part’ of an existing loan used for a personal purpose.
Even though Jenny’s Brisbane home had been repurposed as a rental property, the ATO would only recognise 80% of the original $500,000 loan (i.e. $400,000) as tax deductible, because the $100,000 re-drawn as a deposit for the Melbourne studio was for a personal purpose.
For Jenny, the 80% proportion of the loan which is deductible would remain fixed for the life of the loan. This would prevent her from paying down the non-deductible portion of her overall debt before her tax-deductible debt.
If Jenny had not taken our advice and opted for the redraw facility instead, she would have forfeited both the flexibility necessary for achieving her overall financial planning goals and significant tax benefits.
Your next step…
I suggest you review your home loan documents, taking note of the redraw facility and offset account fine print. If it’s possible to link an offset savings account, I suggest you do, to reduce the amount of interest you will pay on the loan. If you have a redraw facility that suits your circumstances, no action is required. If you are unsure, you should speak to a lending specialist or your adviser.
If the increasing interest rates are motivation for reviewing your current home loan circumstances, we recommend you consult a qualified and licensed lender who will be able to provide options and facilitate a more suitable loan structure for providing future flexibility.
Most importantly, consider your debt strategy as part of, rather than separate to, your overall financial plan.
As Jenny’s story has illustrated, there are financial planning, wealth accumulation and tax matters closely aligned with your lending situation. In my experience, when financial advisers, *lenders, *accountants and lawyers work collaboratively, the client enjoys the best possible outcomes.
To discuss home loan and debt management in context of your overall financial plan for personal prosperity, please contact me (07) 3007 2080 or contact@executivestrategies.com.au
Executive Strategies is a specialised information hub for executives and senior managers who may have founded their own business or who work for growing private, ASX listed companies or government businesses. Its purpose is to provide access to specialist advisers and information that addresses the often-complex issues affecting their personal prosperity.
Stratus Financial Group and its advisers are Authorised Representatives of Fortnum Private Wealth Ltd ABN 54 139 889 535 AFSL 357306. This is general advice only and does not take into account your objectives, financial situation or needs, so you should consider whether the advice is relevant to your personal circumstances. You should also read the relevant Product Disclosure Statements (PDS) before making any financial decision.
*Please note: Tax and lending advice as well as other services relating to this matter not offered under the Fortnum Private Wealth AFSL, in accordance with our collaborative advice model, when required, such matters are referred to appropriately qualified professionals.
