Paying your loans or building funds in the offset?

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Paying your loans or building funds in the offset.

When looking at investing in property paying a loan down is a big decision and I think when people consider it, it’s a goal that many have to reduce the debt that they have.

Now, when you look at your debt it can look good and bad in two ways. At the start it usually doesn’t feel right because you’ve taken on debt that’s usually quite close to the property value and at that point of time the focus is reducing it. The debt can actually also look good when the value’s go up significantly. Now, when people look to manage debt there are so many ways that you can manage it. You can look to pay extra on your loan, put money in your offset. You have values that grow, rents that grow and maybe the debt doesn’t feel so bad because of that but there are a few things to consider. 

When you’re putting money into your loan some people have a redraw facility. This is where say you have a loan of $500,000, you’ve put in $100,000 the loan’s now $400,000 but there’s $100,000 sitting in available funds in the redraw. The pro of that is when your interest or repayments get calculated if you’ve made some tweaks to the repayment structure then the banks will reduce your repayment amount or they’ll keep the repayment at the same but you’ll just be ahead and you’ll also just have a reduced interest cost because of lower interest on the debt that’s there.

There are cons that exist as well because when it comes to property a big part of the investment is also tax. When you’re considering tax if you think of you put in money, you take it out, you put in money, you take it out that starts to confuse things from the tax perspective and what the purpose of the money was used for. Now, imagine your accountant starts getting a headache and even the smallest of mistakes or the things that aren’t input correctly could significantly reduce what you might be able to now deduct your tax on or what you can’t deduct on. This is why there is another strategy where people consider offset accounts. 

Offset accounts are accounts that are attached to your investment loan, they reduce the amount of interest payable based on how much balance is on there. For example, a $500,000 loan with $100,000 in an offset would only incur interest on $400,000, the difference. The key thing that’s there is it’s not considered the loan balance changing when you put in and take out money from an offset account. If you constantly put in and take out or have a large amount of funds and maybe need to deploy that to investing down the track there are less fears on uncertainty from the tax perspectives because money is going in, it’s reducing the interest and you can take it out down the track. It doesn’t usually impact that loan balance because a loan balance still stays the same, it’s just your offset that’s impacting interest that changes. 

Now, why that’s really important to consider is some people like to hammer down extra repayments on a loan or some people like to keep money aside and they don’t want to touch it again. If you’re going back to those tax components that can disrupt that but there’s another part that could disrupt it too. Property values and how much you can borrow. Now, assume say the redraw gets enough or your property doesn’t have or the bank doesn’t have redraw functions on your loan that means you’re placing your payments and payments and payments on the property and say if you need to take out equity or use those payments again you’re actually going to pay interest on the money that you’re increasing that you’ve paid down in cash. Next is you may not get approved for the same amount that you’d put in. 

Lastly, is the valuation may not stack up to equal the same that you put in as well. There are too many variables that could change up what you’d plan to do later on and that money that you had has been going to the bank and it’s now not available in the same way that you’d like it to be. When considering paying extra strategically that many people consider is putting that extra in the offset account because you’re reducing the interest component anyway. Even if you’re going to put that in actual home you are actually still going to have the same principal repayment coming out regardless. 

The only time the principal repayment changes is when you call the bank to make that change or when you have a new application of place to refinance it for a different loan term or you keep it at 30 years and move it away with the reduced debt. That means that your repayments aren’t changing whether you’re putting in extra in the loan or the offset but there are big differences in when you can take that money out. 

When you’re looking to actually consider these sort of things have a look at redraw verse offset understand what the limitations are for the tax perspective speaking to your accountant and also understand if the bank allows you to actually redraw money when you input it back into the home loan. Those pros and cons that we discussed today could be the difference between an investment that you want to buy or just having the right amount of paperwork in the right places for your accounting when it comes to tax time. 

That’s it from us here at InvestorKit the experts in wealth creation helping you to take action.