Are you the right fit for an IO offset account?
An interest only (IO) offset account allows you to combine the savings of not having to pay principal and interest (P&I) along with the opportunity to reduce your overall interest bill.
IO offset accounts also have the added benefit of giving you the flexibility to make extra repayments or withdraw from the account at any time.
This is a great short-term solution for investors who want to invest further and maximise their tax benefits.
How do I qualify?
- Interest only offset account: You can borrow up to 90% of the value of your investment property value with interest only repayments.
- Interest only term: Generally 5-10 years.
- Extending the interest only term: This will often be declined so you may have to refinance in order to do so.
- Loaded interest rate: The bank will generally load or add another 0.1% to 0.55% to their advertised interest rate. Higher rates may apply for loans under $500,000.
- Good financial position: You need to be in a strong financial position and be in a position to make principal and interest (P&I) repayments when your loan invariably switched from interest only.
- Interest only offset accounts for a home loan: May be considered in certain cases.
Interest only offset accounts are generally only approved to property investors.
Please call us on 1300 889 743 or complete our online enquiry form so we can fully assess your suitability for this home loan type.
How does it work?
You’ll make your mortgage repayments as normal except you only make interest payments and not actually paying down the principal component of your mortgage.
In addition to this, you’ll have a 100% offset facility in which you can deposit any extra funds you have in order to reduce your interest bill.
In this way, you can withdraw the funds from the offset as you need them, leave them where they are or make considerable deposits to reduce your interest bill even further.
What are the benefits of interest only offset accounts?
Tax benefits
The main reason is to maximise your tax benefits, particularly in regards to negative gearing.
By not having to pay P&I, you’re keeping tax-deductible loan amount high so you can further reduce your income for tax purposes.
In addition to this, you’re effectively keeping the original debt separate from your savings, which you can use to offset non-tax deductible debt like the mortgage on your own home or even personal loans and credit cards.
The tax benefits of interest only offset accounts can also be leveraged when turning your home into an investment property.
It just takes a bit of creativity and, of course, some help from qualified account who has experience in negative gearing.
Flexibility
You can access your offset funds when you need them in order to continue to build your property portfolio and to avoid missing out on other investment opportunities.
Cash flow buffer
You can maintain or build a cash flow buffer for investment purposes or keep funds on standby for other reasons including:
- Undertaking renovation work to eventually sell the property at a higher price (house flipping).
- Making regular or emergency repairs to your investment property.
- In case of other emergencies or a sudden lifestyle change (it’s good to be prepared).
Who is an interest only offset account for?
As explained above, interest only offset accounts are for property investors and rarely approved for homeowners.
In addition to this, you need to be disciplined in making extra repayments into your offset facility in order to maximise the interest savings and your tax benefits.
You also need a good understanding of the real estate market and buy in growth suburbs that will maximise equity growth since you’re not building it through principal repayments.
In saying this, it is possible to switch your home loan to interest only (without an offset account) in certain cases such as if you’re expecting a child and you’ll be relying on one income for the short-term or you’re temporarily sick or injured and are unable to earn your regular income.
Renting out your property
One of the more common reasons for using an interest only offset account is if you’re planning to turn your home into an investment property.
On a 5-year interest only term, you wouldn’t have started paying down the principal on your loan.
Up until the point that you actually start renting out your property, this loan amount isn’t tax-deductible because you live in the property (residential).
However, during this time, you know you can afford to make extra repayments above interest only.
To get the most tax benefit when you turn your home into an investment, you’re best off making extra payments into an offset account rather than reducing the principal amount.
In this way, you’re maximising your negative gearing benefits.
How does it work?
Let’s say you have a $300,000 home loan on a property worth $400,000 and you managed to pay down $131,000 in 5 years (3.59% p.a. interest rate) just by making P&I repayments.
You make no extra repayments on the loan during this time but you manage to save $100,000 in your offset account and your property value grows to $600,000.
You find your dream home, a city apartment worth $500,000, and you decide to withdraw $100,000 from your 100% offset account towards the purchase (amounts to a 20% deposit).
In this way, you’re not borrowing against the value of your home.
Since you’re now renting out your old place, your tax deductible loan will be based on the net debt in your loan account plus the balance of your offset facility.
Instead of a tax-deductible loan of $269,000, you can add the $100,000 in the offset to bring the tax-deductible loan interest to $369,000.
When you refinance your home loan to an investment loan, you can then switch from the P&I to interest only in order to further bolster your cash flow for further investment or to make extra repayments on your non-tax deductible mortgage or other debts.
What are the drawbacks or red flags of IO offset accounts?
The fact is, you’re not reducing your principal debt so you’re not building your equity as fast as you would be if you were making extra repayments or just the minimum P&I repayments.
This is not an issue if you’ve invested in a strong growth suburb.
It also depends on if you’re eventually aiming for a positively-geared property portfolio and how big you’re planning to grow your portfolio in the first place.
The biggest red flag is when the loan eventually reverts back to principle and interest (P&I) after 5 years (10 years max).
This can catch a lot of people surprise.
Banks and mortgage brokers do their best in trying to determine whether your financial position is strong enough to whether sharp increases in interest rates.
In the end, interest only offset accounts aren’t for borrowers who aren’t disciplined with their spending.
Golden tips
Consider getting tax advice to determine how an interest only offset account fits within your overall property investment strategy, whether you’re going for a negatively-geared or positively-geared portfolio.
In addition, consider the benefits of making P&I over IO payments, as well as extra repayments versus keeping your funds in an offset account.
Example of how an interest only offset account
Let’s say you had a $500,000 30-year term investment loan with an interest rate of 5.5% per annum (p.a.).
You have a 5-year interest only period and over this 5-year IO period, you’ll be paying $2,291.67 per month and then $3,070.44 per month for the remaining 25 years.
If you had an interest only offset account with $15,000 deposited into the facility, you will only make interest payments on $485,000.
So your monthly interest payments for the first 5 years will be $2,222.92 which amounts to a saving of around $825 per year for the first 5 years.
Call us on 1300 889 743 or complete our free assessment form to discover if you qualify for an interest only offset account.