Save interest repayments in offset or use the money to invest?

I currently have 50/50 fixed/variable interest only loan and have all my savings in my offset account, at current rates this will save about $3500 a year compared to not having any money in offset.

In hindsight, from my calculations, it appears that because of rising interest rates I'd probably have been better off fixing all of it (I'd need $50,000 in my offset account for my repayments to be the same as fixing the whole loan, more if interest keeps rising)

Anyway, the question is...am I better off investing say $50,000 and forgoing the benefits of offset. Obviously this assumes a good return on investment (7% would break even, before tax, compared to having money in offset)

The other consideration is...I would have to pay tax on money made from the investment. But I understand you can claim interest paid as a deduction. So these are the two scenarios:

A) Keep money in offset to save money on the variable portion of IO loan. Claim interest on tax return
B) No money in offset but invest it. Pay tax on profits made from investment. Claim interest (higher amount due to higher interest paid) on tax return

 

Do you have an alternate investment that can beat the guaranteed interest savings grossed up by your marginal tax rate?

And how does this fit into your strategy, are you likely to need the funds for say another property? In which case what is the time frame vs the time frame of an alternate investment.

 

Is the loan you are offsetting deductible or non-deductible?

 

C) lend the money to another entity to invest - a lower income tax paying entity such as a non-working spouse or discretionary trust. you can claim the extra interest and the entity makes the profit.

 

I'm seriously impressed that you've worked out the difference between the total annual offset benefit vs fixing the interest rate.

Maybe I should take my overall financial position and investment decisions more seriously ( I honestly have no idea whether offset or other options are a better choice right now).

 

Guaranteed? No. I was thinking liquid investment like shares or ETFs so yes it will be risky

Not sure what this means. It's a interest only investment home loan

 

I think it depends on your goals.

One thing I never see much mention of when deciding offset vs siphoning the cash towards further investing through stocks etc is cashflow. If your offset balance is high enough that your property is in positively geared, yes your interest portion of the repayments is tax deductible but your repayments will be greater than this each month. I would imagine that at the end of the year you'll get a tax bill where you'd owe money to the ATO, however you've been paying the surplus into the loan so will be locked away. Or you save each month forecasting that you are going to have a tax bill at year end (reasonably responsible I suppose). This will negatively impact cashflow.

If the offset was built up to a level where the property was neutral to slightly positively geared and the remaining funds invested in stocks, yes you might pay tax through profits but only if realised and not through fully franked dividends. You will pay your home loan down slower (assuming no change in repayments) and repayments will have a higher interest component. I think this option will have a positive impact on cashflow. Which is better for wealth generation I wonder? Probably depends on your goals and situation - including cashflow.

 

If the cash is offsetting a non-deductible loan i.e. your PPOR, then the interest saved is after tax. If however, the cash is offsetting a fully deductible loan i.e. an IP, then the interest saved is before tax. This is important when determining the rate of return you require to beat cash in your offset.

 

If the return on the money invested is more than the interest he would have better cashflow.
e.g. interest 5% and return 6%, = 1% ahead.

 

Except you then pay your taxes on that 6%, so suddenly even if you're only on the 32.5% bracket that 6% becomes essentially 4%, and is now lower than the money saved by reducing your loan.

 

If the loan is an investment there would be no difference.

example
$500,000 IO loan at 5% pa with $100,000 in offset account.
The $100,000 is saving you $5,000 per year in interest. Your taxable income has therefore increased by $5,000 pa.

If you remove the $100,000 and invest it at 5% return you will have $5,000 more per year in deductions but also $5,000 more per year in expenses - so you are neither ahead or behind - until there is capital growth or loss.