An ordinary home loan consists of one loan account which, over time, has a balance that decreases as you make repayments and increases as the bank charges interest.
If you’ve made extra repayments the bank usually allows you to redraw these back.
That is fine most of the time, but what if your circumstances change? You might decide to move out of your home and rent it out, or you may need the money for something else.
Don’t put your money in your loan account
Well, if the mortgage is just an ordinary home loan, you could be really disadvantaged from a tax perspective. The tax deductible interest you could claim would be limited to the interest on the loan balance at that time.
By way of example, imagine that you had been diligently paying off your original $500,000 home loan for years and it now had a balance of $100,000.
One day you decide to buy an apartment to live in, redrawing $200,000 for the deposit and renting out your old place. Your new loan would be $300,000 but the deductible investment loan interest in this case would be limited to the interest on the previous $100,000 loan balance.
This isn’t the best tax result.
How can an offset account help?
An investment loan with an offset account is a better solution. This type of loan consists of one loan account and one linked offset account. The loan account works like the loan above but the offset account is special. It’s like an extra bank account linked to the loan where you can park the excess repayments you make.
The account earns no interest, but instead the bank will take the balance into account when calculating your loan interest. If you have a $500,000 loan and $200,000 in the offset account, the bank will calculate interest only on $300,000.
Turning your home into an investment property
While you’re living in the home there is no real difference between the ordinary loan and the loan with an offset. But if you decide to move out of your home and rent it out there’s a huge difference for tax.
Imagine again that you had been paying off your $500,000 loan for years, but this time all extra repayments were put to the offset account. So the loan is now $300,000 with an offset account balance of $200,000 which means that the net debt is $100,000.
You redraw $200,000 for your new place and rent out your old place. Your loan would now stay at $300,000 and the deductible loan interest will be based on the net debt in your loan account of $300,000.
This is a much better tax result. It takes into account the possibility of future changes in your life and still gives you a good tax outcome.
Please call us on 1300 889 743 or enquire online if you’d like further information.
Speak to an accountant
This information is general and has been provided by Lucentor Pty Ltd who are accountants that specialise in tax for property investors.
We recommend that investors obtain financial advice specific to their situation before making any financial investment or decision regarding their finances.