Offset your sentence

Last week we covered how to pay off your mortgage and escape a “life sentence” of mortgage payments.

You can see a copy of that I put on LinkedIn here: Life Sentence

Along this theme, this week, I want to cover offset accounts and how to really maximise them.

An offset can be an amazing tool for reducing your payoff period. Once set up properly, it requires little work from you.

I know some of you have had your offset accounts for years, but before shutting off, it may be worth a breeze through.

One small tip or change could mean $’000 over a mortgage term.

? ? ?By the way, if you don't know and wonder what the image at the top is about, this is my favourite rapper: Offset. With a name like that, I'm a fan. After reading today's note, you may be too!

Today we will cover:

• Offset vs. Redraw account
• Principle 1: Keep as much in your offset account for as long as possible.
• Principle 2: It is the only??bank account you should ever have.
• Principle 3: If have multiple offset facilities, use them, but not too many.
• Principle 4: Don’t pay your loan early – use offset instead.
• Principle 5: Simplify your investment property finances – have one offset for every property.

I’m not going to go into what an offset account is and how it works.

I’ll take that as a given for now, and please, if you need help with that, I can send you a helpful primer for that.

For now, here is a schematic that summarises how to operate it:

When selecting loan options be wary of many things, but if you are not using us, check with your lender whether there is an offset.

Offset vs. Redraw.

There are major differences between “offsets” and “redraws” although lenders and many brokers will often tell you “They are basically the same thing”.

Be wary when you hear this.

An offset facility is a completely different bank account that “sits beside” your home loan.

A redraw facility is not separate from your home loan. It allows you to make extra repayments and withdraw any surplus from your home loan directly.

Financially, they aim to do the same thing: they will shorten your loan term. In almost all cases, if you have an offset account, your lender will allow fee-free redraws, but not vice versa.

There are a few drawbacks on a redraw vs. offset:

• Redraws are manual to run. Very few offer the ability to set up automatic payments in and out so require a lot of manual online transfers to maximise.
• They do not have the same flexibility as offset accounts. For example, with an offset account, you receive a debit card and have access to your funds in real time.

Most lenders require these transactions to be transferred to a transaction account first, not from your loan.

Your home loan becomes blurred with many other transactions. This can make it painstaking to manage.

• A bigger risk and problem for some more than others, but over time our finances do get more complex. If you have two of you paying off your home loan now, if all down through redraw it is very hard to know who has contributed what both in and when making withdrawals.
• PLEASE do not take the following as tax advice: you may want to get your own, but: If for example in future, you want to convert your home into an investment property you will be open to scrutiny by the ATO and they may not allow that loan to be converted to an investment loan because if looks like a personal facility.
• On that line if you do move your home to being an investment property, the ATO only allows the balance of your loan to at that time to be used for investment purposes for tax deductions – you cannot top it up.Offset accounts are not included in this as the ATO only look at the loan itself, not the offset as it is a completely separate transaction account (see an example of this in “Principle 3” below)..

Sometimes not having an offset is the right answer.

If you have no intention and no possibility of making any changes to your home use and just want to pay it off and move on, an objective I fully respect, then a no-frills “basic account” can work. Just make sure it has a much lower interest rate and very low fees as you are giving up a lot of future flexibility.

Principle 1: Keep as much in your offset account for as long as possible

As offset balances and interest on your mortgage are calculated daily, your aim is to leave every last $ in your account as long as possible.

All salary and other receipts should go straight into your offset account automatically.

Hold on to this as long as you can.

This means paying your bills on the day they are due, not prior, and certainly not late, though!

Just set them up to be auto-paid from your offset on each due date.

Use a credit card for everything.

Clearly, you need to know yourself well enough and don’t be tempted to use it as “free money”.

With most credit cards, you have 45 days interest-free. Just set your card to be fully auto-paid off each month form your offset account.

Most offset accounts have a fee-free card facility with them. You also get any bonus airline points, vouchers etc per credit card spend. Hint: take the vouchers and use them for your essentials.

Principle 2: It is the only bank account you should ever have.

Any money you have in other bank accounts is a waste of money, regardless of the interest rate you are getting.

Although you don’t earn interest on an offset account it is saved on your mortgage, effectively after tax. E.g. if your mortgage rate is 6% and your top marginal tax rate is 37% then you are effectively earning 9.5% before tax.

That is how much interest you would need to earn before tax to receive 6% after tax.

This is not declared income in your tax returns so less concern at tax time.

It “should be illegal”. It's definitely not!!

Principle 3: If have multiple offset facilities, use them, but not too many.

Most, but not all, lenders allow several accounts, often a maximum of nine, but some more.

Where this is available, they are cumulative i.e. your offset balance is all your accounts added.

Depending on how you run your finances, these can be very useful.

e.g. a typical dual-income household may choose four offset accounts:

• Account 1. joint household expenses and mortgage repayments. Each contributes a portion from their other account (2&3 below) into this each fortnight for the for the mortgage repayment and household and other essential expenses
• Accounts 2. & 3. Personal account for each earner, where your pay for each goes into with a set amount automatically going into account 1. This allows autonomy on non-essentials of you
• Account 4. A long-term-saving, build-up account for future agreed purposes – not to be touched except for the goal in mind (don’t attach your cards to this account!). There may be one more, such as another emergency fund, but I have seen clients set up many accounts for different types of household spend, and it becomes unwieldy over time (Good morning, Barefoot Investor). As I say, this is only a suggestion, and each person/household is different.

Principle 4: Don’t pay your loan early – use offset instead.

Treat your offset account as your vault for extra savings and early repayments.

If you have read the shortfalls of redraws above, this will make sense.

Remember, you can always access this for whatever use you want in the future. Just don’t close your mortgage if it is fully paid, otherwise you will need to apply again from scratch.

You could end up in the comfortable position of a, say, a 500k mortgage and a $500k offset balance.

You won’t be paying an interest on this.

This can be very useful even if you want to do future renos, help kids out, etc.

Here is a vivid case:

I met a potential client couple a few years ago who had proudly paid off their $1.1 m home loan, so their home was mortgage-free.

They wanted to upgrade their home for their growing family and leave their existing home in Middle Pak, Melbourne, as an investment property.

Unfortunately, they had no tax deductions and no negative gearing on that property. If they had instead paid this into an offset account, they would have been able to claim a tax deduction of approximately $65,000 from their own tax p.a.

Ouch.

Side point: I’m not sure what happened with them; they didn’t take it well and never became clients.

Again, PLEASE do not take any of this as tax advice and seek your own.

Principle 5: Simplify your investment property finances – have one offset for every property.

One useful way I have learned to run your investment properties, especially when it comes to tracking performance and tax time, is to have one offset attached to each property in your portfolio.

The offset account is where all your rent is paid and expenses are paid from.

That way, at any time and at the end of the year, you can give this to your accountant, and that becomes your property's tax statement. (I did say this is not tax advice – please get your own).

I hope this note has given you some useful thoughts.

For clients, if you would like to discuss your own situation, feel free to use this link and book a (video) call: https://fin4nurses.me/clientmeet

Have a Great Week!!