Offset or Cash Deposit in a High Interest Market
One of the most powerful tools I recommend to clients looking to optimise their mortgage repayments and savings is the offset account. This financial instrument not only helps reduce interest costs but also offers tax advantages when compared to alternative strategies like reducing loan balances or using high-interest cash accounts.
We’ve received a lot of enquiry of late around using an offset, or going with high interest cash deposit accounts in this higher rate environment. FYI - at the time of writing the cash rate os 4.35%, and we’re seeing cash deposits as high as 5.3%.
The biggest factor we highlight below, is that savings from an offset are post-tax, so tax free savings. Earnings on cash deposits are pre-tax, and will be taxed at an individuals marginal tax rate.
So for example, interest savings at a home loan rate of say 6.2%, will far exceed a cash deposit rate of 5.3%, which may then be taxed at as much as 45%, reducing earnings to around 2.4%.
There are circumstances where things look different, particularly if you carry purely investment debt and interest is tax deductible, and we’d suggest you chat to your accountant to firm up how this would play out.
How Offset Accounts Work
An offset account is a transaction account linked to your home loan. The balance in this account is offset against the outstanding loan balance, reducing the interest payable on the mortgage. For example, if your mortgage balance is $300,000 and you have $50,000 in your offset account, interest is only charged on $250,000 ($300,000 - $50,000).
Benefits of Offset Accounts
Interest Savings: By reducing the loan balance on which interest is calculated, offset accounts help homeowners save on interest costs over the life of the loan. This will reflect as ‘redraw’ in your home loan, being money you have paid ahead of your minimum monthly repayments (as you’ve paid less interest, and more principal).
Flexibility: Funds in the offset account remain accessible for everyday expenses or emergencies, and the account can be used like any other bank account whilst simultaneously saving you money.
Tax Efficiency: The interest saved through offset accounts is not considered taxable income, unlike interest earned in high-interest cash accounts, which may be subject to tax.
Alternatives to Offset Accounts
Reducing Loan Balance: Making extra repayments directly reduces the principal amount of the loan, thereby reducing future interest payments. However, these funds are not available for everyday use, needing to be ‘redrawn’ from the home loan before use.
High-Interest Cash Accounts: Placing savings in high-interest cash accounts offers competitive interest rates but may be subject to income tax on the interest earned, reducing overall returns.
Tax Implications of Offset Accounts vs. Cash Earnings
Offset Accounts: Interest savings are effectively tax-free given they’re a cost saving on a post-tax expense (your mortgage). This can result in greater net savings compared to taxable interest earnings in a cash account.
Cash Earnings: Interest earned on savings in high-interest cash accounts is taxable as income. Depending on your tax bracket, a portion of these earnings will be paid as tax, reducing the effective return on investment.
Tax-deductible debt: If all of your debt is already tax deductible, ie. it’s for investment or business purpose, offset savings are likely to have different tax implications as you are reducing a taxable expense (interest).
Considerations for Using Offset Accounts
Financial Goals: Assess whether reducing interest costs or maintaining liquidity is more beneficial based on your financial objectives.
Tax Efficiency: Consult with a tax advisor to understand how offset savings and cash earnings impact your overall tax liability, particularly if your debt is tax deductible.
Conclusion
In conclusion, offset accounts are a versatile financial tool that not only reduces mortgage interest but also provides tax advantages compared to alternative savings strategies. By strategically managing your finances through an offset account, you can effectively maximise savings while maintaining liquidity for day-to-day needs.
