All Topics / Help Needed! / Offset Account v Principal Pay Down

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  • Profile photo of wezwazwezwaz
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    @wezwaz
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    Is there any practical difference in holding cash in an offset account, as opposed to using that cash to pay off the principal? Obviously, in an offset account the cash is readily available for use. But by the same token, you can redraw.

    With cash in an offset account, you pay interest only on the outstanding loan amount, which seems to be the same as if you have paid it off the principal. Is there actually a fundamental difference I've missed? Thanks.

    Profile photo of PaulliePaullie
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    The problem with paying down the principal is that.

    A) You limit your tax deductibility in the future if you want to move house.

    B) You risk contaminating the loan if you redraw to purchase something not for the purpose of investing.

    Either way, you'll have done you dough.

    Always go IO and Offset. The only time I would suggest go P&I is if you were not a disciplined saver.

    Profile photo of TerrywTerryw
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    There is a huge difference!

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
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    Profile photo of wezwazwezwaz
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    Whoops! I was talking about PPOR, so I won't be paying interest only. I know there are many strategies, but in a world that is drowning in debt, getting rid of it is probably the best option. When growth appears unlikely, gearing helps no-one, whether it be property or the share market.

    Profile photo of Jamie MooreJamie Moore
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    Paullie has provided excellent advice above. If you're an undisciplined saver and will only make the minimum interest repayments then IO with an offset is not for you.

    You're not necessarily drowning in debt if you make regular repayments into your offset and avoid withdrawing (unless it's for a good purpose).

    Cheers

    Jamie

    Jamie Moore | Pass Go Home Loans Pty Ltd
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    Profile photo of Solomon10Solomon10
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    I have wondered this too for a ppor,suppose im quite sure i will be there a while, what is the difference for having say a 200 k mortgage with no offset,paying it down to say 110 k,to having it the same 90 k in an offset account? Will the ato be sus if i found another house to live in and just pulled my 90 k out to use on the next house?

    Profile photo of Jamie MooreJamie Moore
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    Solomon10 wrote:
    I have wondered this too for a ppor,suppose im quite sure i will be there a while, what is the difference for having say a 200 k mortgage with no offset,paying it down to say 110 k,to having it the same 90 k in an offset account? Will the ato be sus if i found another house to live in and just pulled my 90 k out to use on the next house?

    If the $90k is being used for an IP it should be deductible. If it's being used for a PPOR it won't be.

    If you have $90k sitting in your offset and moved it on to your next PPOR, you would have boosted your deductible debt by $90k (which is a good thing) and reduced your non-deductible debt by $90k (also a good thing).

    If you have a slight inkling that your PPOR will one day become an IP, don't pay down any more principle. I wrote an article for API magazine recently on this topic – it's available here

    Cheers

    Jamie

    Cheers

    Jamie

    Jamie Moore | Pass Go Home Loans Pty Ltd
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    Profile photo of Solomon10Solomon10
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        Thanks for your explanation Jamie, i understand that much,including the article you linked to. But what is the difference from just re-drawing the amount to take it across to your new ppor? Would the ato frown upon deliberately increasing deductible debt and reducing non deductible?

    Profile photo of TerrywTerryw
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    Solomon10 wrote:
        Thanks for your explanation Jamie, i understand that much,including the article you linked to. But what is the difference from just re-drawing the amount to take it across to your new ppor? Would the ato frown upon deliberately increasing deductible debt and reducing non deductible?

    Withdrawing from a loan = new borrowings

    What determines deductibility? The purpose those funds will be used for.

    So, if you redraw from a loan and then buy a private residence (PPOR) with it then the interest won't be dedutible.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
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    Profile photo of ljfljf
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    Hi guys!

    This is my first post on the forums!

    Thanks so much for this information, Jamie M. I'd heard that I/O & offset was the only way to go if you wanted to turn your PPOR into an IP, but I couldn't find the information that led to this conculusion, though I'd been searching for it.

    My fiance and I took out a home loan for our first PPOR November 2011 (just a few months ago). I requested an offset account, but the mortgage broker we spoke to said redraw was pretty much the same thing, and the more he discussed it, the more I got confused and forgot why I wanted it! 

    Now I've ended up with a P&I home loan with redraw facility , and we plan to make this an Investment Property in a few year's time…  .. Considering I've spent the last year or two researching property (reading books, magazines, attending seminars), I was pretty annoyed at myself for this rookie mistake.
    We only had a small deposit though, so it might have had something to do with the options that were available to us.

    I think I need to speak with the bank and find out if I can turn the loan into an I/O & offset.
    In the next year and a half we're saving for the wedding and I was planning to have this money offset the loan.

    Thanks again for your wisdom, Jamie M.

    Kind regards,

    Louise

    Profile photo of Jamie MooreJamie Moore
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    ljf wrote:
    Hi guys!

    This is my first post on the forums!

    Thanks so much for this information, Jamie M. I'd heard that I/O & offset was the only way to go if you wanted to turn your PPOR into an IP, but I couldn't find the information that led to this conculusion, though I'd been searching for it.

    My fiance and I took out a home loan for our first PPOR November 2011 (just a few months ago). I requested an offset account, but the mortgage broker we spoke to said redraw was pretty much the same thing, and the more he discussed it, the more I got confused and forgot why I wanted it! 

    Now I've ended up with a P&I home loan with redraw facility , and we plan to make this an Investment Property in a few year's time…  .. Considering I've spent the last year or two researching property (reading books, magazines, attending seminars), I was pretty annoyed at myself for this rookie mistake.
    We only had a small deposit though, so it might have had something to do with the options that were available to us.

    I think I need to speak with the bank and find out if I can turn the loan into an I/O & offset.
    In the next year and a half we're saving for the wedding and I was planning to have this money offset the loan.

    Thanks again for your wisdom, Jamie M.

    Kind regards,

    Louise

    Hi Louise

    No worries at all. I'm glad that you find the information useful :)

    As you said – ask the lender if converting to an IO product with an offset is a possibility. There might be a small fee involved but it's worth it.

    If not, and if you used at least a 20% deposit, then it would be worth while looking to carry out an external refi. There will be some costs involved, but at least you won't be slugged with a Deferred Establishment Fee (DEF) for leaving as your loan settled after the new law passed banning DEF's.

    Given that this is going to become an IP – you already know that it doesn't make sense paying down the principle and redraw is a big no no.

    Cheers

    Jamie

    Jamie Moore | Pass Go Home Loans Pty Ltd
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    Profile photo of wezwazwezwaz
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    Thanks Jamie, for the tip. This has been an eye opener!

    I want to present a further scenario on the article you wrote for API:

    Say I have bought my PPOR for $450k with a $330k loan. After depositing money into my offset account, it eventually reaches a balance of $330k. Obviously, then I am paying no interest. On the other hand I'm not getting any interest on a wad of $330k, which isn't ideal. If you've effectively extinguished the loan, will the loan provider expect you to close it out?

    I only have a vague idea that my PPOR may become a rental in the future – probably at least 15 – 20 years away. How do I weigh up the best way to go?

    Wes.

    Profile photo of Jamie MooreJamie Moore
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    Hi wezwaz

    The bank won’t ask you to close the facility.

    You won’t be earning interest on the $330k but if you took it out, you’d be paying interest on your home loan.

    If you have an inkling that your PPOR will become an IP at some point, I wouldn’t pay off that debt.

    If faced with this scenerio you should have a word with your accountant as well.

    Cheers

    Jamie

    Jamie Moore | Pass Go Home Loans Pty Ltd
    http://www.passgo.com.au
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    Profile photo of wezwazwezwaz
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    Jamie (or anyone who wants to contribute)

    I want to revisit this topic…

    I admit I don't know enough about the ins and outs of property, but have been thinking about all the contributions to my post.

    Let's say I have no inkling whatsoever that my PPOR may one day become a rental property. It would seem the best solution still would be to extinguish interest on the loan by completely offsetting the principal, i.e. I take out a loan of $300,000, say, and contribute $300,000 to my offset account as quick as I can. Therefore, I am now paying no interest. I effectively own the property, but have the flexibility to draw that money out as indicated previously to put into a PPOR (should I decide to move). That would save me paying down non-deductible debt again.

    So is my strategy sound? Convert P&I to an interest only loan, and completely offset the principal on my PPOR using the offset account as quickly as possible? To clarify a bit further, I have no notion at this point that I will ever move from this property and I have the ability to offset the principal quite quickly – in less than 3 years, maybe even quicker.

    Maybe I am stating the bleeding obvious to experienced property investors, but I just want to be very clear before I change anything. Thanks for any advice you can contribute.

    Wes.

    Profile photo of TerrywTerryw
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    yes that is the beststrategy just in case..
    he only reason not to do this is if you are tempted by large sums of money
    t

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
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    Profile photo of Jamie MooreJamie Moore
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    Hi Wes

    I'm a little lost with your post but if you're 100% sure your PPOR will never become an IP, then pay down the principle on your PPOR and borrow against it when you're ready to invest.

    Cheers

    Jamie

    Jamie Moore | Pass Go Home Loans Pty Ltd
    http://www.passgo.com.au
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    Profile photo of Cameron McEvoyCameron McEvoy
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    I agree with many of the comments on here.
    It 100% does depend on the way you intend to use the property (or indeed properties) in the future.

    If you are certain the PPOR you are in now; will remain a PPOR for 15-20 years, then making the loan P&I is the way to go.

    But if the place is only a short-term ‘home’ (say just a couple of years; using as a stepping stone to a different property, for example), then setting it up as IO for the longevity of the loan is the best thing to do.

    Just remember your ‘cake base’ (for most investors, this is usually the first property you purchased; probably as a PPOR, before drawing equity out of it to fund future IP’s). This is the property where you should either be paying P&I (if you are occupying it), or if it is rented out, you should be pushing cash into an offset account held against this property, and not others.

    I made this mistake for the past two years until my accountant recently corrected me on it.
    The lines then get further blurred when you move in and out of different properties. Some say you should ‘only buy IP’s for investment, and never use them at any time for PPOR purposes’. But I disagree.

    I just settled my 4th property, which is to be my PPOR for the next few years at least. I have set it up as IO (along with my other three properties, even my first ‘cake base’ purchase’), but pouring all my ‘offset’ cash into an offset account against this fourth one (and not my first purchase), with the intent of making this fourth property my new ‘cake base’.

    This means that future property purchases will draw from the equity in property #4, not property #1 (like I have been doing). One of the influencing reasons for this is because property #4 is actually more expensive than #1, and has greater capital growth prospects than property #1.

    I blogged more about ‘cake-base’ strategy here:

    http://www.propertyspectator.blogspot.com.au/2012/04/building-your-cake-base-six-year-itch.html

    But after reading some comments I don’t think I got it quite right.
    I’d be really interested in hearing more from those who have applied such a shifting strategy in their portfolio.

    Cheers,

    Profile photo of wezwazwezwaz
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    Jamie M wrote:
    Hi Wes

    I'm a little lost with your post but if you're 100% sure your PPOR will never become an IP, then pay down the principle on your PPOR and borrow against it when you're ready to invest.

    Cheers

    Jamie

    OK Jamie, let me have another go and in reference to Cameron's reply also…

    Currently I have a 15 year P&I loan for $330,000 – at least I did when I started it last Nov. Some principal has obviously been paid down.

    1. Right now I have no idea whether I will be there for more than 15 years or not. My idea after reading threads in this post was to dump $330,000 into my offset account to effectively give me ownership and be paying no interest, and to do this as quickly as possible. Unless I miss my guess, this then gives me options: if I stay there and believe at a later date that I won't be moving, then I can shut the loan out with the funds in my offset account, or if I decide to move, it becomes a rental that is tax effective.

    2. In the other scenario, if I complete my commitment and pay back P&I, I will own my PPOR, but I have NO options should I decide to move out. I will have "done my dough". I then have to start the process all over again in taking up another PPOR, do I not?

    It was stated in one of the earlier posts the bank wouldn't require me to close out the loan should I completely offset the principal, so that's what I'm working on. Surely scenario 1. gives me the best options. If not, what have I overlooked? Thanks.

    Wes.

    Profile photo of TerrywTerryw
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    Wes,

    If you had $300,000 cash in the bank would you be tempted to buy something you may otherwise not have bought? Many would.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of Jamie MooreJamie Moore
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    wezwaz wrote:
    Jamie M wrote:
    Hi Wes

    I'm a little lost with your post but if you're 100% sure your PPOR will never become an IP, then pay down the principle on your PPOR and borrow against it when you're ready to invest.

    Cheers

    Jamie

    OK Jamie, let me have another go and in reference to Cameron's reply also…

    Currently I have a 15 year P&I loan for $330,000 – at least I did when I started it last Nov. Some principal has obviously been paid down.

    1. Right now I have no idea whether I will be there for more than 15 years or not. My idea after reading threads in this post was to dump $330,000 into my offset account to effectively give me ownership and be paying no interest, and to do this as quickly as possible. Unless I miss my guess, this then gives me options: if I stay there and believe at a later date that I won't be moving, then I can shut the loan out with the funds in my offset account, or if I decide to move, it becomes a rental that is tax effective.

    2. In the other scenario, if I complete my commitment and pay back P&I, I will own my PPOR, but I have NO options should I decide to move out. I will have "done my dough". I then have to start the process all over again in taking up another PPOR, do I not?

    It was stated in one of the earlier posts the bank wouldn't require me to close out the loan should I completely offset the principal, so that's what I'm working on. Surely scenario 1. gives me the best options. If not, what have I overlooked? Thanks.

    Wes.

    Hi Wes,

    Yep – you're on the money, scenario 1 would be the way to go, providing you have the discipline to continue making regular repayments into your offset account and avoid simply paying the minimum interest repayments.

    Cheers

    Jamie

    Jamie Moore | Pass Go Home Loans Pty Ltd
    http://www.passgo.com.au
    Email Me | Phone Me

    Mortgage Broker assisting clients Australia wide Email: [email protected]

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