Interest Only Home Loans with an Offset Account

Structuring your mortgage to suit your needs and achieve more beneficial tax outcomes.

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, updated on August 8th, 2023       

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Because home buyers have a range of needs and long-term financial goals, mortgages come in a variety of forms, each with their own nuances. One way a mortgage can be structured to suit buyers is in the form of an interest only home loan with an attached offset account.

This article will outline exactly what this type of home loan structure entails, as well as how this structure can be used to best benefit first home buyers in terms of retaining financial flexibility, as well as property investors who are seeking to optimise their debt to achieve more beneficial tax outcomes.

Making sense of an interest only period and offset account

What do the terms ‘principle’ and ‘interest’ actually refer to?

Principle is the value of the total amount borrowed and is equivalent to the total value of the property being purchased, minus your deposit, plus other fees and costs such as stamp duty and conveyancing.

Interest is a percentage value of the total loan amount outstanding which lenders charge in order to make profits from offering financing.

I understand how a home loan works, but what does ‘interest only’ mean?

An interest only home loan means that your loan agreement will include a period which will require you to service only the interest on your outstanding debt, and not the principle. Once this period has ended, you will need to begin to pay down the principle, as well as interest.

For example:

You have borrowed $500,000 to purchase property, and are being charged interest at 5% per annum. Your loan includes an interest only period of 5 years.

The annual interest on this loan will be $25,000, making your monthly repayments $2,083 for the first 5 years of your total repayment period.

Once this 5-year period has elapsed and you must make payments towards the principle of your loan as well as interest, your monthly payments going forward will be $3,954.

Okay, that makes sense. So how does an ‘offset account’ factor into this?

An offset account is an account attached to your loan which can act as a regular bank account, except that the balance of this account will be deducted from the total loan amount that you are paying interest on.

For example:
You set up an offset account with your interest only mortgage. Now as well as making your monthly $2,083 interest payments, you are able to save a further $2,000 per month in your offset account.

After one year, you will have accumulated $24,000 in this account, meaning the amount that you must continue to pay interest on will have been reduced from the initial borrowing amount of $500,000 to $476,000.

By keeping cash in your offset account, you can continue to reduce the total amount of interest paid during your interest only period, or can choose to use this offset account to make additional repayments on your loan.

Maintaining financial flexibility

One of the more compelling reasons one might opt to apply for an interest only loan with an offset account is that by saving this lump sum rather than spending the funds immediately on loan repayments, you maintain the ability to use your funds to make other investments should you choose to, or respond to unexpected life events, such as dealing with an injury or illness.

Not only does this allow you to hold funds in reserve, but for those who wish to expand their property portfolio, an interest only loan and offset account can provide further added benefits.

Still wondering how an interest only home loan works?

Why might I opt for an interest only home loan?

One of the more compelling reasons one might opt to apply for an interest only loan with an offset account is that by saving this lump sum rather than spending the funds immediately on loan repayments, you maintain the ability to use your funds to make other investments should you choose to, or respond to unexpected life events, such as dealing with an injury or illness.

Can this type of home loan and offset account assist me with investment properties?

Yes. Having built up savings in your offset account, it is possible to purchase another property, using this amount as a deposit, and assigning your new property as your primary place of residence (PPR) for tax purposes.

What other impact can this have on my property portfolio?

Because current negative gearing policies allow for expenses on investment properties to be deducted as tax expenses, the interest payments outstanding on your first property can be written off come tax time. By using an offset account to accumulate savings during your interest only period, you can simultaneously save for the deposit on your second property, while maximising the amount of remaining interest payable on the loan for your first property, therefore leading to higher total deductible tax expenses on what would then be classified as an investment property.

This all sounds complicated, what does this mean in layperson’s terms?

Without using finance and tax jargon, what this means is that by using this method, it is possible to rent out your investment property and pay down the principal of the mortgage on that property using your rental income. Because the interest payments are refundable tax expenses, this works in your favour when you file your tax return. In one sense, this provides you with an interest-free home loan.

Can I still make additional repayments towards the home loan on my investment property?

 

If you choose to follow this scheme, you can still contribute any surplus funds towards the mortgage on your investment property. This will ultimately reduce the amount of interest repayments that you can write off as expenses, but if it suits you to do this, there’s no reason that you can’t.

What are the downsides to an interest only home loan?

Possible downsides to this type of mortgage lie in the higher barrier to entry- most banks will require a deposit in the area of 20% of the total property purchase price in order to offer an interest only period.

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