Financial deregulation and keen competition between lenders have greatly expanded the options available to borrowers. Among the many improvements is the widespread availability of mortgage offset accounts.
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These accounts offer the same benefits as paying off a mortgage with one major difference. The money deposited in the account can be withdrawn at any time. This arrangement offers major tax advantages for borrowers to pay off owner-occupied properties (which don't offer tax deductions on interest) while still retaining access to the money.
As the name suggests, the interest credited on the deposits in the offset account directly reduces the amount of interest payable on the outstanding mortgage. Compared with depositing money into a separate savings account where any interest accruing adds to taxable income, using a mortgage offset account generates no tax burdens.
There are further advantages of using offset accounts. For example, when wanting to upgrade the family home and retain the existing residence as an investment, having money in an offset account offers a big bonus. The tax laws don't allow a tax deduction for interest payment on new borrowing against an existing property to buy a new residence.
However, all interest payments on existing debt on the investment property is tax deductible. Withdrawing money from the mortgage offset account to help fund the new residence will increase the interest payable on the original mortgage. All of this interest cost will be tax deductible because the loan was taken out to buy the property now being used for investment purposes.
Concentrating on building up an offset account rather than paying off the mortgage more quickly also gives greater flexibility in dealing with the lending institution. If, say, there's difficulty in meeting the required monthly loan servicing costs, money in the offset account can be used for this purpose without any contact with the lender.
Having a mortgage offset account can help fund major consumer durable outlays and even a replacement car without using more expensive credit card or consumer debt. Again this is permitted and even encouraged by financial institutions offering offset accounts facilities against their loan.
The biggest advantage of offset accounts is that there are no adverse tax consequences of using these account to build up short or long-term savings. Although not currently used for this purpose, retirees could even use a mortgage offset account long term, such as a 30-year loan, in the same way as a reverse mortgage.
Reverse mortgages involve drawing upon the equity in a fully owned home to help fund retirement with the interest being capitalised in the loan. A mortgage offset account can be used for the same purpose provided there's a sufficient balance to allow drawdowns and to service ongoing mortgage costs.
Daryl Dixon is the executive chairman of Dixon Advisory. comments@dixon.com.au
