Cake it and Eat it

Owl Rating: Owlet

Savings, it seems to be something that people, even people in debt want to have. It is understandable to have some level of savings for emergencies and the like. Generally, I like holding around three month's worth of salary as savings, this way, I can obtain 90 day waiting period personal protection insurance thereby lowering the premium of the insurance while still being prepared. In any case, three month's worth of salary as savings tends to give a healthy buffer in the event that life interrupts with your plan.

The problem is, people with debt should not have savings unless of course their return on savings after tax are greater than their return on debt. Remember, it is advisable that someone has some level of savings, it is a typical case of having your cake and eating it too. However, in finance, it is possible to have the cake and eat it as well. The solution is in the form of mortgage offset accounts for mortgages, some personal loans allow redraws as well.

Mortgage offset accounts:

A mortgage offset account is an account that runs concurrent to your mortgage. Suppose you have a mortgage for $150,000 and have $20,000 in the offset account. This would effectively reduce your mortgage to $130,000 on which you will pay interest. When seeking a mortgage offset account, see something that:

• has no balance limit
• where the total balance is offset, that is 100% mortgage offset
• has an equal interest rate to your mortgage

Another thing that you really should pay attention to is the difference between the interest rate for a loan with a mortgage offset account attached and a basic variable loan (for which an offset account cannot be obtained). Sometimes the difference can be 0.75% or more which is significant over the life of the loan and certainly reduces the benefit of the mortgage offset account.

Advantages:

• you pay tax on your interest earnt at your marginal tax rate, with a mortgage offset account, you do not pay tax on the interest savings, it is in effect, a tax savings
• you save on interest, suppose the example I gave of $150,000 has an interest rate of 6.50%. Without any offset, you would pay $153,843 in interest over the course of a 25 year mortgage, with the $20,000 offset you would pay $133,330 over the term of the loan, significant savings by all accounts.
• you can deposit all excess funds in the account knowing that you can withdraw at any time. This means that the above interest savings can increase even further by depositing your salary into the account and just withdrawing what you need to live on.

Disadvantages:

• Not really a disadvantage, but discipline is required, once the mortgage offset account gets very large, it becomes tempting to tap into it to increase your lifestyle
• Time-consuming, this is perhaps one of the biggest factors with a lot of finance, it is considered time consuming to shop around for products to find the most appropriate one

In short, the right mortgage offset account can provide significant benefits to you. The key thing is to look into the products carefully and factor in the differences. Loans which allow a re-draw are fairly similar to a mortgage offset account loan. A simple calculator that I created to compare a standard mortgage, standard mortgage with an offset and a basic mortgage can be downloaded here.