Impact of Offset on total repayments

Discussion in 'Loans & Mortgage Brokers' started by propernewb, 18th Oct, 2017.

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  1. propernewb

    propernewb Well-Known Member

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    Hi All,

    How does the offset impact the total amount repayable on a loan? I realise that it reduces the interest payable on a loan, but would it also reduce the principal too? If so, does the offset somehow get absorbed into the loan as a final repayment at maturity?
     
  2. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    An offset reduces the interest charged on the loan. Only a loan repayment made in excess of interest reduces principal.

    If you get to the point where offset has same amount as the loan you could repay the debt.
     
  3. Property Twins

    Property Twins Mortgage Brokers & Buyers Agents Business Member

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    Is it a P&I or an IO loan? If IO - you pay interest on the balance.

    If P&I - the repayments remain as per usual, interest is payable on the balance and hence a larger principal amount is reduced every month. Thereby reverse compounding
     
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  4. propernewb

    propernewb Well-Known Member

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    Thanks Paul,

    So that would mean the minimum repayment required would be reduced. But if I continued to make the same repayments, then I could potentially pay off the principal sooner?
    Also, if I were to suddenly withdraw all the contents of the offset, would I then expect repayments to increase to cover the increase in interest repayments?
     
  5. Marg4000

    Marg4000 Well-Known Member

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    The minimum monthly payment won't change.

    Just think, if it did payments would have to be adjusted monthly, an impossible exercise. Depending on the amount in the offset, which can fluctuate wildly, any excess paid will come off the principal.
    Marg
     
  6. Zoolander

    Zoolander Well-Known Member

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    The monthly repayments are fixed (for PI at least). The more you have in offset, the more of the principle you're paying down. If you pull all the offset out then the proportion going to interest would rise.

    Back of evenlope numbers:
    I get charged $2000/mth. With some offset in play only $200 of that $2k is interest. Youre paying down the princple $1.8k that month.
    With less offset, the interest proportion balloons out to $1000.

    @Marg4000 beat me to it :)
     
  7. Zoolander

    Zoolander Well-Known Member

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    For interest only loans my repayments vary depending on how much is in the offset. Given the principle is on the sidelines for the duration of the IO term.
     
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  8. Marg4000

    Marg4000 Well-Known Member

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    Never had IO loans. So do you get an account each month telling you how much interest to pay?
    Marg
     
  9. propernewb

    propernewb Well-Known Member

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    Hi Property Twins,

    Yes it is a P&I loan.
     
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  10. Zoolander

    Zoolander Well-Known Member

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    It gets deducted from my nominated account each month or week. Realisticly, the offset grows gradular as savings are added which dont impact all that much on the repayments. its how it works with my NAB. Some second tier lenders like Liberty need you to ask specifically for a repayment recalculation after depositing a high sum into their redraw (More than $10k). They dont have the tech or manpower to do this automatically.
     
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  11. propernewb

    propernewb Well-Known Member

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    Thanks @Marg4000 and @Zoolander!

    I think I understand now.
    The repayments remain fixed for a P&I loan - an offset will just increase the proportion of the payment that is directed towards the principal. Therefore, an offset would reduce the time required to completely pay off the loan.
    If that is the case, what happens to the offset once you reach the end of the loan? Do you get it back, or does the mortgagee take it?
     
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  12. Marg4000

    Marg4000 Well-Known Member

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    You NEVER let the offset amount exceed the amount owing!

    When our offset equalled the loan amount, we simply arranged for the monthly payment to come out of the offset account so the balances remained equal. (No interest involved). Over a couple of years the money gradually transferred from the offset to the loan until both arrived at a nil balance.
    Marg
     
  13. propernewb

    propernewb Well-Known Member

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    Sorry for the silly questions, but why not? Is it because the cost of doing so would be greater than just paying off the mortgage?
    Also, why not completely pay off the mortgage once the offset is equal to the loan?
    Finally, do offset accounts accumulate interest as a transaction account/savings account would?
     
  14. Zoolander

    Zoolander Well-Known Member

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    Would you rather have $xxx,xxx available to invest or use for emergencies; or $0? Paying off the loan means giving all those doolarydoos in your offset to the bank, never to be seen again.
     
  15. propernewb

    propernewb Well-Known Member

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    Yes, I thought that would be the case but I just wanted to be sure. So in summary:
    • Offsets reduce the interest component of your repayment
    • For a P&I loan, your repayments remain fixed; your interest component is reduced; and your principal component is increased; thereby accelerating the rate at the which you pay off your loan
    • For an IO loan, your repayments change according to the calculated interest component. Principal does not get repaid (as would be expected for an IO loan) during the IO period.
    • The contents of the offset account can become large enough to cover the minimum repayments of a mortgage
    • There is an opportunity cost in liquidating the mortgage, should the funds in offset equal that of the mortgage balance
    • Offset balance should not be greater than mortgage balance. I guess this isn't an impossible to do, but it just wouldn't make sense from an investment point of view
    • Unsure if funds in offset account accumulate interest
    Thanks all!
     
  16. Marg4000

    Marg4000 Well-Known Member

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    1. Because if the offset amount is greater than the loan amount you don't get any extra reduction in interest, you are simply giving your bank an interest free loan. Put the extra money elsewhere. Sure, you will only earn a pittance, but that is better than nothing. Better still, offset another loan if you have one.

    2. Flexibility - you have instant access to the money in the offset should the need arise. Of course you could pay off the loan, but a loan equalled by an offset gradually paying it off is not costing you anything as no interest is charged. Set and forget.

    3. Offset accounts don't earn any interest. (Hence answer #1). They simply offset the amount borrowed and interest is charged on the loan amount minus the amount in the offset account.
    Marg
     
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  17. AlexV_Sydney

    AlexV_Sydney Well-Known Member

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    as I understood from Terry's advices, for tax deductibility for future investments it's better to pay it off and then use Redraw to borrow again, rather than to use offset as deposit for next IP.
     
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  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

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    If fully offset it would pay itself off in about 14 years:
    Loan Tip: If a PI loan was fully offset how soon would it be repaid? Loan Tip: If a PI loan was fully offset how soon would it be repaid?
     
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