In many situations when I’m working with a buyer with a low loan size and no strong need for a package option with the banks - I’ll often recommend a basic home loan. The contrast to this is the package options that many banks offer that come typically with offset facilities and an annual fee – usually around $395 per year at the time of writing.
If however the person wants to rent their property out in the future (say 5 years down the track it’s a high likelihood) AND they have capacity to be making extra repayments really comfortably I’ll often recommend a package option for the offset features.
Here’s why: If you feel you are likely to want to rent this property out in the future what we want to be careful around is having you live in the home for say 5 years paying it down rapidly and then for us to try and use it as an investment property.
If we do this after you’ve paid down a significant amount of debt, we cannot add that debt back on from a tax deductible perspective. If instead we have an offset account you can make the minimum monthly repayments to the home, maximum to the offset account/s and you've still got the same net benefit that is (whatever is in the offset accounts you're not paying interest on).
The only key difference here if you pull money out of redraw on a home loan for a purpose that is not investment related, the ATO deem those funds now “non tax deductible” however you can pull it out of an offset account you can do so without it impacting the end tax deductibility of the loan (when you rent the property out).
Let’s look at a hypothetical example:
Sally and Jim buy a property for $350,000 and her end loan is $320,000. They live in it for 3 years and then wishes to buy another property to live in while renting this out. Sally and Jim are both working with no children. Over the next 5 years they are able to pay their normal home loan repayments plus another $7,800 per year – which is $150 per week in extra repayments.
For the purposes of this exercise we’ll assume their interest rate doesn’t change during the period – all figures are approximate and we’ll use an interest rate of 4.5% (purely to illustrate).
Option 1 – basic product, no offset
Jim and Sally pay their minimum home loan repayments and their extra $150 per week consistently extra straight into their loan.
After 5 years:
- Home loan balance $253,000 (note if they continued on this way they’d have their home loan paid off 12 years early!)
- Redraw $39,000
They now wish to rent their home out and they withdraw their $39,000 in redraw to use as a contribution towards their new home.
The tax-deductible portion of the home loan as far as interest repayments go is now only $253,000 (the balance prior to drawing out the redraw) not $292,000 the balance after they’ve drawn out the redraw.
Let’s say interest repayments are at 4.5% ongoing so therefore we’re looking at tax deductible interest of around $11,300 of interest deductions per year to start.
Option 2 – Package product with offset
Jim and Sally pay their minimum home loan repayments and put their extra $150 per week consistently extra straight into their offset. (Now with an offset it’s preferable to use it for all your cash – ie: with each person’s pays going into it etc, but for the purposes of this exercise let’s just limit it to the extra $150 per week.
After 5 years:
- Home loan balance $292,000
- Offset balance $39,000
- Same interest charges during this time as above (if we assume the same interest rate – products may vary), but an extra $395 per year in annual fees (so let’s say an extra $2,000 in fees).
They now wish to rent their home out and they withdraw their $39,000 from offset to use as a contribution towards their new home.
The tax-deductible portion of the home loan as far as interest repayments go is now $292,000 (the funds haven’t been withdrawn from the home).
Let’s say interest repayments are at 4.5% ongoing so therefore we’re looking at tax deductible interest of around $13,140 of interest deductions per year to start. If the people involved have a tax rate of say 50% then after around 3 years the benefits are stronger as far as having had the offset account and keeping the debt on their loan which is going to be tax deductible.
Ultimately, there are a lot of assumptions in the above. The more you can afford to pay off your home loan during the time you live in it, the stronger the rationale for having an offset account is if you feel you’re going to rent the property out. The larger your loan size, also the stronger the case towards it (given the fee spread is lower).