Hi, I’ve just made the decision not to go with an offset account with my loan for my first investment property and wanted to outline my thoughts around this to see what other people think. I always thought an offset account is a great idea, but once I did the maths, it didn’t look that great anymore.
A few assumptions first:
Fixed rate: 3.74% for two years
Variable rate: 4.17%
Savings account rate: 3.15% (RAMS offers a savings account with 1.5% interest plus 1.65% bonus interest which is easy to get)
I intended to put $80k in the variable loan based on my mortgage brokers recommendation which is again based on our estimated possible savings over the next two years. But that is assuming our situation doesn’t change, but we’re planning a family and that would mean we loose one income for a while and hence we would be able to save less or nothing during that time, so there is a risk to it.So, here is my calculation:
Compared to a scenario where we fix the whole loan we pay 4.17% – 3.74% = 0.43% more on the $80k, which equates to $344 per year, i.e. we pay this amount just for the opportunity to have an offset account, which basically means that we can save money at the rate of the variable loan instead of at the normal savings account rate.In order to make this worthwhile, we need to make use of the offset account with an amount that allows us to save interest of at least $344 per year compared to the interest we get in the savings account. The interest in the offset account is 4.17% – 3.15% = 1.02% higher than in our savings account. That would mean we would have to hold $344 / 1.02% = $33,725 in the offset account ON AVERAGE across the whole period of two years (until we refinance) in order to make up for the higher interest paid and the offset account fee. ON AVERAGE and assuming a linear increase over time in the offset account (for simplification reasons) would mean we have to get to $67,550 in the offset account just to break even.
OK, now we could simply put a lower amount into the offset account, maybe only $40k, which would mean we break even if we reach $33,725 after two years. More realistic, but since we only break even at that amount, and only gain if we exceed this amount (which is only possible up to the limit of $40k anyway, so only another $6,275) we would rather talk about peanuts that we gain from this (in the best case, i.e. we reach the $40k after two years we would gain, $6,275/2*1.02%=$32 per year – I divided it by two because it is again the interest on the average amount across the whole period).
OK, again, you could assume that you don’t start at 0 but maybe rather at, let’s say $10k in the offset account, which would mean you break even earlier, but in total this would only bring in an additional $10,000 * 1.02% = $102 per year.
The fact, that you can always repay on the fixed rate loan as well (our lender allows up to $25k per year) makes the offset account even less worthwhile. Another reason against an offset account from my POV is that you are basically limited to saving all your money in the offset account as you feel that you have to in order to make it worthwhile. So, instead of making use of opportunities elsewhere (e.g. stocks, additional super payments, fixed term, etc) you always feel limited to the offset account, which probably is not always the best choice.
Looking forward to your thoughts on that :-)
Remember that any interest gain is taxable if it is outside and offset account. If in an offset account it is deamed as savings therefore your “return” is whatever the variable rate is. For example 4.17% variable isa 4.17% tax free savings so effectively a return in reverse :)
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This reply was modified 8 years, 4 months ago by
Colin Rice.
Colin Rice | CDR Finance
http://cdrfinance.com.au/
Email Me | Phone MePerth Based Mortgage Broker - Investment Property Finance Specialist | E: [email protected]
Thanks Colin. But isn’t the saved interest in an offset account not also technically taxed? If your property is positively geared, you pay tax on the surplus, if it’s negatively geared you reduce your taxable income by the amount of the loss. So, if you pay less interest on your loan due to savings, your property gets more positive or less negatively geared and hence you technically pay tax on these interest savings as well, no?
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This reply was modified 8 years, 4 months ago by Bjoern.
The ultimate aim in my eyes is to have an asses that has the potential to increase in value and also earns an income (puts money in your pocket).
Like my accountant says, if you are paying tax it means you are earning money and there aint nothing wrong with that :)
Colin Rice | CDR Finance
http://cdrfinance.com.au/
Email Me | Phone MePerth Based Mortgage Broker - Investment Property Finance Specialist | E: [email protected]
Hi Colin,
thanks for your quick reply. I think my last post was maybe not that clear, so now using some numbers as an example. So, assuming the following:
Rental income per year: $10k
Interest paid on the loan plus other cost: $8k
–> Profit from property $2k, so tax has to be paid on $2k income from the propertyNow, we also have savings that generate $200 interest in either savings or offset account (should be a different amount of interest, but for simplicity reasons let’s assume it’s the same interest rate).
1.) If we put this money into a savings account, we receive interest from savings of $200 which we have to pay tax on, so in total we pay tax on $2.200 due to the property and our savings
2.) If we put the money into the offset account instead, we save interest of $200 on our loan, so now we only pay $1.800 in interest and other cost and hence our profit from the property is now $10k – $7.8k = $2.200
So in both cases, your interest received (savings account) or your interest saved (offset account) is taxed the same way, no?How much is the debt on the IP?
Do you have a PPOR with debt?
Colin Rice | CDR Finance
http://cdrfinance.com.au/
Email Me | Phone MePerth Based Mortgage Broker - Investment Property Finance Specialist | E: [email protected]
The value difference here is under the assumption that the fixed option is cheaper than the variable – what if rates drop further?
A lot of people would have come to the same line of thinking and chosen 4.99% fixes not that long ago instead of variable with offset, only to see themselves paying 1% more than if they went variable.
How many market commentators + banks are already talking about a further two rate decreases?
Corey Batt | Precision Funding
http://www.precisionfunding.com.au
Email Me | Phone MeInvestment Focused Finance Strategist - servicing Australia-wide
@corey, I agree on a 2 year fixed….but on a 5 year fixed…..sounds like cheap insurance to me. Basically allows an investor to sleep soundly at night for at least the next 4 years and then consider selling when the fixed term period runs out in 5 years from now rather than being in a situation where you are at the whim of the banks who can raise rates at any time…..
@Bjoern, your maths is correct….if it costs you more for the offset and you don’t expect to have $30k in it then don’t get it. This said…..shop around as some banks offer it at no additional expense.
I would hold off on a five year fixed for at least 12 months. I believe they will continue to trend downwards.
My opinion only of course and not actual advice.
Colin Rice | CDR Finance
http://cdrfinance.com.au/
Email Me | Phone MePerth Based Mortgage Broker - Investment Property Finance Specialist | E: [email protected]
@corey, I agree on a 2 year fixed….but on a 5 year fixed…..sounds like cheap insurance to me. Basically allows an investor to sleep soundly at night for at least the next 4 years and then consider selling when the fixed term period runs out in 5 years from now rather than being in a situation where you are at the whim of the banks who can raise rates at any time…..
@Bjoern, your maths is correct….if it costs you more for the offset and you don’t expect to have $30k in it then don’t get it. This said…..shop around as some banks offer it at no additional expense.And that’s the way fixed rates should be looked at – a risk mitigant. That is completely different to the OP’s question however which is based on rate differentials, which with the latest cut alone would have seen them worse off. Use fixed rates to manage risk, not gamble for the cheapest option.
Corey Batt | Precision Funding
http://www.precisionfunding.com.au
Email Me | Phone MeInvestment Focused Finance Strategist - servicing Australia-wide
Hi Bjoern,
I think your over thinking/complicating the idea of an offset account…
The way I see it is interest for bank deposits is a lot lower than the interest we pay on an average home loan.
Where would you rather put your spare cash to work for you ?
Would you rather be “earning” interest on a low interest rate or “saving” interest on a high interest rate? I always say a dollar saved is the same as a dollar made, it’s money in your pocket.
Saving tax shouldn’t be a motivating factor for investing. So if money in the offset account is allowing you to keep more of your rental income then happy days, it’s more income/savings.
And if paying more tax on the extra income is still a concern just remember the depreciation benefits of an IP that will most likely offset the extra income anyway. Win win in my view.
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This reply was modified 8 years, 4 months ago by pascoe_82.
Hi Bjoern,
Though you may be correct with the “numbers” (i.e. if you save interest via the Offset it has you paying a bit more Tax as you have less Interest expense), to me the MAJOR advantage of an Offset Account is the flexibility it provides you!!
It allows you to keep the original Mortgage untouched while “paying it down” via the Offset Account (Interest payments are reduced by the same amount as if you had paid it back to the Bank).
But, if you HAD paid it back to a Bank instead, you would be having to make application to them for another (LOC?) account to buy Shares, or whatever. With an Offset, it is all YOUR Tax-paid money and it is immediately available to you – you don’t need to ask the Bank – you just take it !! For Shares, as a Deposit on another IP, whatever you want…..
That is so easy in comparison – what is that “ease” worth to you? ;)
Benny
Great comments, everyone!
My 2c are:
1. Is the only reason the OP is considering to split the loan is to have access to offset? that’s only one aspect to consider, really. I prefer all my loans these days as variable as my personal view is that the rates will go down down down over the next few years. The calculations in the OP didn’t account for a scenario in which the rates go down (or up for that matter).
2. Having an offset facility is not available with all lenders on all loans and may cost more in % (I.e. You could get a cheaper loan without offset). Did you consider redraw? (ideally without drawing fees and low minimum amount at a time)
Hope this helps? :-)
Ethan Timor | Aligned Finance Pty Ltd
http://www.alignedfinance.com.au/
Email Me | Phone MeActive Investor & Broker; Based in Northern NSW, servicing Australia wide; Author of '34 Proven Ways to Maximise Your Borrowing Power' (download free from our website)
Thanks for all your responses, guys!
@pascoe: Agree, I probably overcomplicated it and in the end we’re probably discussing about max a few $100 difference anyway. But also wanted to get feedback if my thinking is correct. And I don’t think the interest on a savings account is that much lower. I get 3.15% at RAMS right now and the loan was 3.69% in the end (variable would have been 4.17%). And a savings account is not the only option for where to put your money. Definitely, saving tax is no motivating factor. Otherwise, I could just give all my wealth away and quit my job – wouldn’t have to pay any tax then ;-)
@benny: Yes, agree flexibility is a key aspect. But I think it is not limited by not having an offset account. I still don’t have to pay down the mortgage, but I can rather put the money into my savings account. OK, I get less interest on it, but also I don’t have to pay additional interest on the variable portion of the loan (As per the calc above).
@ethan: Good thought, I also played the scenario of continually dropping interest rates through, just didn’t put it my post here. The conclusion I came to is that the interest rate differential is 0.48%, so that is almost two fully passed on rate reductions. Since I only fixed the loan for 2 years and I’m saving money as long as the fixed rate is below the variable rate, keeping it variable would mean that I only break even if there are 4 fully passed on rate reductions in the next 2 years (similarly as above assuming equal intervalls for each reduction). I guess even with an extremely positive outlook (or negative if you think from an economy perspective) that is not very likely to happen.
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This reply was modified 8 years, 4 months ago by
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