The differences that can save you money & TAX!
The lending terms, home loan redraw and offset account, are often misunderstood. Mostly, because both arrangements allow borrowers to make extra payments toward their home loan (to reduce the interest on the loan), as well as the ability to access this extra funding if needed for other purposes. However, there are differences between the two that can impact flexibility and importantly, future tax efficiencies.
In simple terms, home loan redraw is a facility that forms part of a home loan agreement, while an offset account is a separate account that is linked to the home loan.
For those with surplus cash and an ability to pay more than minimum loan repayments these arrangements can be an effective approach for debt management. They are particularly useful for those who may need the extra payments later for a particular purpose or to take advantage of an unexpected opportunity.
When using an offset account arrangement, surplus cash or extra home loan payments are deposited into a linked account that is recognised by the lender as a means for reducing the effective loan balance and therefore interest payable .
However, the differences are more apparent should the borrower decide to use some, or all, of the extra funds.
Withdrawing funds using a redraw facility can be subject to conditions set by the lender. These may include a predetermined limit for the amount of funds that can be redrawn. It’s also worth noting, the lender can impose fees for accessing redraw funds or could even deny a redraw request entirely.
However, linked offset accounts generally have no such restrictions. This is because funds are withdrawn from a separate, albeit linked savings account, rather than from a facility that is part of the home loan agreement.
Then, there’s the matter of future tax deductibility of the loan.
In my experience advising mining and resources professionals and executives, at different stages of their careers they are required to relocate either interstate or overseas.
Naturally, this involves moving house and making decisions that can include retaining an existing home as well as purchasing a house in the new location. For those who decide to keep their existing home and repurpose it as a rental property, they may take advantage of the home loan structure to pay a deposit on a new family home. As you will read in the following case study, a linked home loan offset account may deliver a more favourable tax efficiency than a redraw facility.
Case Study
Bill is a mining and resources executive who has accepted a new role, and along with his family will transfer from Perth to Brisbane. He and his wife Jane have been repaying a $500,000 home loan on their Perth family home. They have made higher than required repayments and accumulated $100,000 in their re-draw facility.
Bill and Jane have decided to keep their Perth property and rent it out as they hope to generate additional income and claim tax deductions on expenses which include the interest on their home loan. They intend to use the $100,000 held in their re-draw facility as the deposit on their new family home in Brisbane.
In this situation, from a tax perspective, the ATO considers the purpose of the borrowed funds when determining the deductibility of a loan.
For Bill and Jane, the $100,000 re-draw monies will be used for the personal purpose of purchasing a family home, therefore, these redrawn funds are not tax-deductible.
This means that even though their Perth home has been repurposed as a rental, only $400,000 or 80% of their $500,000 home loan, is tax deductible.
As the loan balance changes over time, and because the proportion of tax deductibility remains fixed at 80%, it will mean Bill and Jane will not be able to separate and repay the non-deductible debt before the deductible debt. Every dollar of repayment will reduce both the non-tax deductible AND the tax-deductible parts of the loan, which goes against common debt strategy of repaying the non tax-deductible part of the debt first.
Conversely, if Bill and Jane had opted for a linked home loan offset account for saving their $100,000 advance repayments, then used that money as a deposit for their new Brisbane family home, it would have remained separate from their $500,000 home loan commitment on their Perth property. This would have provided greater flexibility and tax efficiencies for them, as it allows interest on the full $500,000 loan to be deductible for tax purposes. Further, it would allow them to pay down their non-deductible debt as quickly as possible, while benefiting from the tax-deductible entitlements of their Perth rental property home loan.
Your next step…
Given the highly competitive nature of the current lending environment, your next step (whether you are relocating or not) would include:
-Reviewing your current home loan structure*;
-Seeking advice on alternative loan arrangements*, and
-Understanding the opportunities and benefits in context of your overall financial position of savings, wealth generation and tax efficiencies that could result.
For time poor mining and resources executives and professionals, we understand it can be difficult to devote the time needed for coordinating comparison home loan information and analysing the best possible scenarios for your particular financial circumstances, especially in context of changing career circumstances.
As qualified financial advisers, we collaborate with other professionals to present the information needed for decision making across the various aspects that make up an individual’s financial life. For matters such as those described here, we consult with both lending and tax professionals on our clients’ behalf to tailor an approach that’s right for them. If we can help you manage your financial affairs, please contact James Marshall on (07) 3007 2000 or contact@resourcesunearthed.com.au
Resources Unearthed is a solutions hub that provides integrated financial, legal, property and accounting & business advisory services for executives, professionals and business owners in the mining and resources sectors.
Stratus Financial Group and its advisers are Authorised Representatives of Fortnum Private Wealth ABN 54 139 889 535 AFSL 357306. This information does not consider your personal circumstances and is of a general nature only. You should not act on it without first obtaining professional financial advice specific to your circumstances.
*Please note: As advice and services relating to this matter are not offered under the Fortnum Private Wealth AFSL, in accordance with our collaborative advice model, when required, such matters are referred to appropriately qualified professionals.
