Should I pay off my mortgage or leave it in my offset account?

Announcer considers the pros and cons.

I’m confused – my bank teller is telling me to transfer my savings onto my mortgage but you are encouraging me to leave the money in my offset account. Isn’t the end result the same? Why am I being told something different from the bank?

Great question!

Besides the obvious answer that the banks would prefer the security of having your savings paying off the money they have lent you, most home owners understand that regardless of the approach you adopt, interest on your home loan is calculated on the same basis. Some believe the only difference between paying off your home loan account and placing your savings in an offset account is the flexibility of having easier access to your savings by having it sitting in your offset account. This flexibility of instant access however, is negated if you have a redraw facility on your loan account.

While the interest savings are the same, there may be very different tax considerations, particularly if the property is for investment purposes or going to be used as an investment in the future. Just because the loan is secured by an investment property, it does not mean that all interest payments are deductible for tax purposes if you redraw on the facility.

Your ability to claim a tax deduction for interest on the total loan is determined by the purpose of use of the borrowed funds.

By way of example… Let’s say you purchase an investment property and obtain an initial loan of $300,000. You then create savings over time of $30,000.

Redraw facility

If you paid the $30,000 off the loan balance (reducing the original loan to $270,000) then later redraw the $30,000 to buy a new car (increasing the loan back to $300,000), you would only be able to claim a deduction for interest on $270,000 as the $30,000 would be deemed to have been used to purchase the car (not a taxable item). This can create accounting nightmares at tax time.

Offset accounts

If you had, however, paid the $30,000 into the offset account, you will have obtained the interest savings by paying interest on the $270,000 balance. When you later withdraw the amount from the offset account to buy the car, the initial loan balance would have remained untouched and all interest would still be deductible as the total loan was used for the purchase of the investment property.

Maintaining flexibility on your home

This situation also applies to your home. In many instances you will sell your family home to buy a new one. If however you want to keep your family home for investment purposes at a later date and you have paid down the original loan rather than putting your savings into an offset account, you will potentially lose valuable tax deductions. As the financial impacts are the same, placing your savings into an offset account preserves your options into the unknown future. For example, if you know in advance as a first home owner that you will be upgrading your unit to a home in the future and plan on keeping the unit as an investment, it is of particular importance to protect your future tax deductibility while maintaining maximum home ownership. It all relies on the structure of your loan and future flexibility – something that most lending institution employees don’t understand. I hope that answers your question.