Where to park savings - IO vs P&I offset?

Discussion in 'Property Finance' started by lauz358, 31st Oct, 2018.

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  1. lauz358

    lauz358 Member

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    Hi guys,

    I'm sure this is going to be a dumb question, but I've never been good at maths so thought I'd throw it out there for the brains trust.

    IP1 - IO loan, fixed interest rate at 4.49%, 100% offset, with NAB

    IP2 - P&I loan, fixed interest rate at 3.99%, partial offset (MISA), with CBA

    In which offset should I be parking most of my savings to get the most value? (and if any more info is of value in order to figure this out, let me know.) I did a quick search of the forum to find an answer, but most questions don't discuss this in the context of the two loans being P&I and IO.

    Thank you so much!
     
  2. chylld

    chylld Well-Known Member

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    At first glance, parking as much as possible in IP1 will save you the most interest, as IP1's interest rate and offset% is higher.

    However, the P&I repayments on IP2 will stay the same even if IP2 is fully offset, resulting in more of each repayment reducing the principal, which could have flow-on effects.

    How does the CBA MISA work?
     
  3. Peter_Tersteeg

    Peter_Tersteeg Finance broker and strategist Business Member

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    As a general rule (and if there's no tax implications which there aren't in this case):

    Offset accounts save you interest...
    ...so put the cash in the offset account against the loan with the higher interest rate.



    The other thing is that partial offset accounts, such as the one on the CBA fixed loan, are almost worthless. I wouldn't bother putting anything in there until the NAB loan is fully offset.
     
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  4. Lindsay_W

    Lindsay_W Well-Known Member

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    To get the most benefit, the loan with the 100% Offset account and higher interest rate makes sense and would be my pick.
    Not advice
     
  5. Peter_Tersteeg

    Peter_Tersteeg Finance broker and strategist Business Member

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    Fairly badly in this case because it's a fixed rate. Normally the CBA MISA is a non-transactional offset account, but the fixed rate means it attracts the same interest as a savings account, then that's credited back against the interest you're charged.

    Let's say the loan is fully offset ($100k owing and $100k in the MISA account). If the current CBA savings account is giving 1% and the loan is at 3.99%, you're still effectively paying 2.99% on the loan. It's better than nothing, but not much better than a regular savings account.
     
  6. chylld

    chylld Well-Known Member

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    Thanks for the simple explanation. That's a shocker. Glad CBA have proper offset accounts now!
     
  7. Peter_Tersteeg

    Peter_Tersteeg Finance broker and strategist Business Member

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    It's not so much a problem with the MISA account, it's a problem with how offset accounts are applied to fixed rates (if they do anything at all). Bankwest's offset account works the same way for fixed rates.

    The CBA MISA account has only limited use because it's not transactional. You need to transfer money to it from another CBA account. It can't be used for depositing salary and making payments. It took them about 20 years, but the CBA eventually did do better with the Streamline account implementation a few years ago.
     
  8. chylld

    chylld Well-Known Member

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    I simulated the outcomes based on the following assumptions:
    • 20-year loan term, 1 repayment a year (for simplicity)
    • IO loan reverts to P&I after 10 years
    • $100k IO loan 4.49% fully offset
    • $100k P&I loan 4.49% fully offset (ignore MISA shortcomings for now)
    • $100k cash to put into either offset
    If all cash is put into the IO loan offset, the total amount repaid across both loans over 20 years is $247,033.22.
    io.png

    If all cash is put into the P&I offset, the total repayment is higher at $271,216.69. No surprise there.
    pi.png

    However, the total repayment is lowest when $65.3k is put into the IO offset, and $34.7k is put into the P&I offset! Total repayment is then $235,685.93...
    optimum.png

    Quite a surprising outcome..... I suspect the true optimum is to put $100k into one offset, and then when IO reverts to P&I, move it to the other offset... I haven't figured out which yet.
     
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  9. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

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    We don't know if there will be any tax implications in this case.

    Is the ownership structure of IP1 and IP2 exactly the same?

    Assuming they are, putting cash in the IO loan offset will improve cashflow, and save the most interest.

    But how do you get a fixed rate with an offset?
     
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  10. TheSackedWiggle

    TheSackedWiggle Well-Known Member

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    and here I was scratching my head over the same question,
    it was one of those moment from your school days when you have a question you think might be dumb one and the smartest guy in the class ask that :)
     
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  11. chylld

    chylld Well-Known Member

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    Figured out the optimal solution for my scenario above, and I don't understand it at all. Nonetheless it does at least begin to answer OP's question about prioritising offset cash between IO and P&I loans.

    The lowest total repayment figure that I was able to achieve was $231,343.60. This is significantly lower than the total figure obtained by putting all $100k offset cash in one offset or the other:
    ss (2018-10-31 at 02.30.12).png

    The mechanics to achieve this are quite strange:
    • Start off with as much cash as possible into the P&I offset, but never more than the outstanding balance (for obvious reasons) [8 years]
    • For some reason, move all offset cash to the IO offset for a while [2 years]
    • Once the IO loan reverts to P&I, keep as much cash as possible in the IO offset, up to the IO balance (put the rest into P&I offset) [2 years]
    • Once there is enough offset cash to offset both loans, just put enough into each in order to offset both
    clip (2018-10-31 at 02.30.32).png
     
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  12. jazzsidana

    jazzsidana Mortgage Brokers - Investment Savvy Business Member

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    lol.. I honestly was scratching my head on this one..

    Thanks @Terry_w for asking it :)

    In fact, I almost had number dialling on my phone, till I read this :p


    Cheers,
     
  13. tobe

    tobe Well-Known Member

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    The OP said both loans are fixed....
    Offset doesn’t apply during the fixed term, or badly as Peter mentioned.
     
  14. Peter_Tersteeg

    Peter_Tersteeg Finance broker and strategist Business Member

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    Did that change or did I misread it earlier today?

    NAB doesn't have offset accounts for fixed loans, so that kind of resolves the question anyway.
     
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  15. paulF

    paulF Well-Known Member

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    @chylld , Great effort, i recall there was another thread that tried to deal with this kind of problem before and don't think we managed to get to an actual solution for the problem but you seem to be a lot close to the answer.
     
  16. chylld

    chylld Well-Known Member

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    Thanks @paulF... after sleeping on it, I've come to the realisation that my findings were largely due to the fact that the 'optimum' plan simply paid off the loans faster, thus incurring less interest. However there is still some mystery around why the IO loan should be offset during years 9-10, before it reverts.
     
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  17. paulF

    paulF Well-Known Member

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    @chylld , i have a feeling that the two year period will change depending on the Interest rate difference between the two loans
     
  18. neK

    neK Well-Known Member

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    @chylld it does seem strange at first, one would think that offsetting the higher rate would create the biggest difference.

    It comes down the reduction in payment in the IO when the IO loan is offset.
    Much like the "rent money is dead money" - its only dead money if you do nothing productive with the surplus. In this case, the reduced payment on the IO loan is assumed to be spent.

    If the IO loan payments were maintained at the same level (pre and post offset), then that would create the optimum result.
     
  19. lauz358

    lauz358 Member

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    Ownership structure of IP1 & IP2 is exactly the same.

    Thanks everyone for the responses, especially @chylld, those calculations are impressive. It makes me feel less like a dumbass, knowing that the question elicited such an extensive discussion, and this has helped me out a lot. Cheers!
     
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