Loan Tip: Should you always offset the loan with the highest interest rate?

Discussion in 'Loans & Mortgage Brokers' started by Terry_w, 19th Aug, 2021.

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  1. Terry_w

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

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    Generally, the loan with the highest interest rate would be the best one to offset as this will save you the most interest. But this is not always the case.


    The simplest example is offsetting the non-deductible loan first:


    Example 1

    Homer has a paid off main residence and

    Investment loan relating to a property in his name with an interest rate of 3%

    An investment loan relating to his holiday home at 2.5%


    Homer would be better off offsetting the holiday home loan because the interest on this home is not deductible.


    Example 2

    Homer owns Investment Property 1 with an interest rate of 3%

    Marge owns Investment Property 2 with a loan interest rate of 2.5%

    Homer is on the top tax bracket, Marge isn’t working.


    They would save more money overall by offsetting Marge’s loans.

    If $100,000 cash was in the offset for

    Homer the interest saved would be $3,000

    Marge the interest saved would be $2,500

    But Homer would pay $1,410 in extra tax

    Marge would pay no extra tax

    So Homer’s net saving would be $1,590 whereas Marge would be saving $2,500
     
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  2. craigc

    craigc Well-Known Member

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    Effectively the best offset is the highest marginal after-tax interest rate.

    Non-deductible loans (or no/minimal deductions) would generally be first as @Terry_w mentions.
     
  3. QldGuy

    QldGuy Member

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    The highest rate is probably going to be no higher than about 4-5% at the moment. There is lots of potential investments with better rate of return.
    Is there any other reason to keep it in offset, or is it just because it is a low risk option?
     
  4. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    That's a fair point, but there's no doubt that it's good to have some amount of money available as cash. For some people it might only be $10k, for other's it's more. It's the money that allows you to deal with something unexpected. Cash allow you to deal with problems quickly in an emergency. An offset account is about the best return you can get for cash.
     
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  5. QldGuy

    QldGuy Member

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    Makes sense. Thanks for clearing that up.