Where should your extra savings go when you have a mortgage?

When a bank assesses your ability to repay a mortgage the assessment rate it’s higher than the actual interest rate. So for example, if your home loan interest rate is 4.00% the bank may be looking to see if you can repay 7.25% or even 8%! 

Now what that means for the bank, is that they are being conservative and also allowing for interest rates to rise (which they no doubt will over the life of a 30 year loan!) 

What it means for you is that you should NOT be down to spending your last dollar by the time your mortgage repayment comes out each week, fortnight or month.  You should have money left over.

So, what should you do with this extra money?

Now of course this depends on your individual circumstances and we’re so happy to discuss this with you personally if you’re one of our clients, but here’s a little simple guide we’ve prepared that may give you a nice handy starting point:

Who are you? (find your type)

Type 1. 

You own one property (your own home that you live in)

You have no intention of renting that home out in the near future if at all

You have a basic home loan (with redraw, but no offset) 

Then your savings have the greatest capacity to help you save in your home loan.

Here’s why: Let’s say your home loan’s interest rate is 3.99% (a common big bank basic home loan at the time of writing) and your savings account earns 2.8% (a common ING, ME bank interest rate at the time of writing). If you keep your money in the savings account you earn 2.8% which the government then taxes you on meaning that interest rate is likely eroded to around 2% (ish – remember, this it isn’t tailored to your exact situation). But”¦ 2% interest earnings vs interest savings of 3.99% – that’s some pretty simple math there.

Remember: Make sure your home loan has redraw and be sure you don’t want to rent out the property (as the potential strategy differs then).

Extra bonus: As home loan interest rates go up, you’ll have built up a buffer in your home loan to prepare you for this and the more money you can put into your mortgage earlier the dramatic difference this will make to your repayments over time.

Type 2. 

You own one property (your own home that you live in)

You are pretty sure you want to rent this property out in the future.

You have a basic home loan (with redraw, but no offset) 

Talk to your accountant and then a broker and see whether a home loan with an offset account is going to prepare you better for that next step of renting your home out. 

Here’s why: Let’s say you’re an awesome saver and you get your home loan paid down considerably – when you go to rent it out and want to buy another property, you’ll have your debt stacked more against the home that will not be tax deductible than the one that will (the future rental). Having an offset account can be more costly in the short term (with some lenders), but it also protects you so that you have potentially the best outcome based on where your debt is situated later on down the track. Remember, once you’ve paid down debt against a property you cannot simply re-borrow it later on down the track and have it become tax deductible.

Remember: Talk to your accountant! 

Extra bonus: Some lenders have multiple offset accounts, great for saving into different categories or buckets such as holiday saving, kids education etc.

Type 3. 

You own one property (your own home that you live in)

You may or may not want to rent this property out in the future. 

You have a package home loan with offset options.  

Then typically the best case for your savings is in your offset account (or accounts if you have multiple offset accounts). 

Here’s why: Funds in a 100% offset serve the same value (saving you interest) in an offset account as they do in your home loan. 

Remember: Sometimes these packages with offset accounts can be more expensive (with annual fees etc) so be sure that you’re talking to your accountant and broker to confirm that the option you’re on is the best option for your situation. Also, if you’re the person who from a mental perspective is more inclined to spend the funds if they’re in an offset account as opposed to being in your loan then this again is something worth considering as a factor in terms of where you keep extra savings. 

Type 4. 

You own multiple properties (including your own home that you live in + one more investment)

You have no intention of renting the home you live in out in the near future if at all

You have a basic home loan (with redraw, but no offset) 

As always with anything to do with investment properties, confirm with your accountant, but if you have no future plans to rent out your own home you should be fine to follow the same strategy for Type 1 and put the funds into your home loan accessible via redraw.    

Type 5. 

You own multiple properties (including your own home that you live in + one more investment)

You have a package home loan which has an offset option 

As always with anything to do with investment properties, confirm with your accountant, but it is likely the recommendation here will be to have your offset (or offsets!) focussed against the home you are living in given that debt is likely to have no or limited tax advantages. 

Remember: If you have offset your own home entirely then most lenders can set up or activate offsets against your investment debt, again as always, confirm with your accountant.  

So what about my splurge and mojo accounts?! I love Scott Pape and the Barefoot Investor community for all they’re doing in terms of getting the Australian public talking about money and taking away from the stigma associated with those conversations. However, at the risk of being rather controversial, I think it’s hard for Scott to provide one size fits all advice for people and I think it’s important that everyone takes their advice from multiple sources and picks what works best for them. I think the pure cost savings (if you have a home loan) of utilising your savings (be they still called Mojo and Splurge etc, either as offset accounts OR just in a spreadsheet you use to keep track of how much amazing redraw you’ve built up in your home loan) to lower your home loan debt drastically have the potential to far outweigh the benefit of keeping them separately.

Kirsty

Other helpful reading include these articles:

https://www.uploans.com.au/blog/2015/06/22/why-would-you-consider-an-offset-account/

https://www.uploans.com.au/blog/2017/04/18/how-to-pay-off-your-mortgage-(and-other-associated-debt)-faster/