Interest offset accounts are a great way to manage debt. They introduce a flexibility to a client’s debt management that can be a great benefit down the track.
With an interest offset account, a loan account (usually a mortgage account) is connected to a normal savings or transaction account. The amount of interest payable on the loan account is calculated by subtracting the balance in the offset account from the amount owing on the loan. So, if the loan account has $110,000 owing on it, and the offset account has $10,000 in it, interest is only payable on $100,000.
In terms of interest expense, therefore, money saved into the offset account has the same effect as money paid off the home loan. But, because the saved money is in a separate account, it can be accessed immediately, without having to make a redraw on the home loan. Amongst other benefits, this means that the main purpose of the home loan remains buying the property. This can be of great benefit to best-practice tax planning. Let us explain:
Suppose a couple buy a property worth $500,000. They have $100,000 in cash. They use $50,000 as a deposit and they borrow $450,000. They use an offset account and live in the property. Immediately, the amount that they are paying interest on is reduced to $400,000 by the $50,000 in the offset account. Over the next five years, they simply pay the interest on the loan account. Instead of paying down the principal, they save an extra $200,000 into the offset account. Effectively, then, they have reduced their debt to $200,000, because this is the amount they pay interest on.
The couple then decide that they want to buy another property to live in, but keep the first property as an investment. They take the $250,000 in the offset account and use it as a deposit on the second property, borrowing the rest (with another associated offset account – they can of course do the whole thing again). This means they are now paying interest on the full $450,000 borrowed in the first loan, which was taken out to buy the first property. Because this property is now rented, the interest paid on this account is now tax deductible. The $250,000 in cash has been used to reduce the interest payable on the loan required to buy the second property. This interest is not tax deductible.
You can see, then, how the offset account has the effect of letting the couple move equity from the first property to the second one, but without needing to transfer title, incur stamp duties, etc.
The average period of owning a home is just on ten years. For units the period of ownership is even shorter. This means that most homeowners will move house several times across their lifetime. Buying-and-then-not-selling homes can be a simple and cheap way to develop a substantial property portfolio. Offset accounts let this be done while minimising transaction costs.
You can read more about this and other strategies here: Dover’s non-deductible debt management materials. Please take the time to read these materials as even a small goal kicked for a client with regards to debt management expands out to large gains as things compound over time. Most advisers find that the strategies here more than pay for themselves over time.