You can pay off your mortgage quicker, easier and cheaper, says money mentor Nicole Pedersen-McKinnon in this preview of her 12-Step Prosperity Plan, to be released on Friday.
It’s often said the only real way to pay off a home loan early is to somehow make extra repayments, whether you manage that by getting a better deal or finding money. But that’s not true – there is a strategy that lets you do it without leaving a hole in your pocket. What’s more, despite record low deposit interest rates, this will give you decent, secure returns on cash.
The mortgage offset account – an Australian innovation that’s been adopted across the world – has changed the face of debt reduction. It is in one of these remarkable facilities that you should house EVERYTHING. Your emergency fund, savings for your next house, holiday and replacement car, school fees, your salary…
In an offset ALL this money will reduce your mortgage interest but you can still spend it later – it’s like using every dollar twice. The strategy is so good that a higher-rate taxpayer would actually need a before-tax return of nearly 11 per cent before they would be better off investing (assuming a 6 per cent mortgage). So a high-interest savings account never measures up.
What makes offset accounts so good? Any money you hold in them is “offset” against the money you owe – so you pay no interest on that amount. For example, if you have $10,000 sitting beside a $100,000 loan, you’ll only pay interest on $90,000. Mathematically you get an identical benefit to putting extra money directly onto the mortgage: a risk-free, tax-free effective return equal to your interest rate. And debt freedom probably years early.
But there are two very important differences if you instead use an offset account:
- One: you retain complete access
- Two: the loan is never technically paid down (I’ll get to the reason this is vital in a moment).
You, like many others, may think that by making extra mortgage repayments you are protecting yourself against rate rises and loss of income. The idea is that if you are ahead and you get into financial strife, you could stop repayments for a while.
Well you can’t unless the bank explicitly waives the requirement. You are contracted to make a monthly repayment come what may. It may be possible to redraw what you have overpaid (for a fee) and drip feed it back in but this is far from certain. Lenders can stop you from taking out overpayments if you are no longer working, preferring to reserve that money to protect themselves. So at the very time you need it most, your money might be locked away from you.
But this is not even the most compelling reason… it’s that your loan balance doesn’t actually fall but is only deemed to fall. This is a crucial distinction if there’s the faintest chance you’ll later convert your home into an investment property. By reducing your loan balance, you’re cutting yourself out of future tax deductions and committing a mistake that will cost thousands of dollars a year.
You are only able to claim interest deductions for investment properties on your lowest-ever balance –so if you pay it down, you lose them forever. It’s no good either to take out a larger loan against the now-investment property (or to redraw from the loan) to buy your new home. What matters to the tax office is the use of money you borrow rather than where you get it from.
Is there any chance you’ll turn your home into an investment property? Then immediately stop making extra repayments into the loan itself and begin making them into an offset account. You’ll safeguard your deductions and build a cash deposit for your new home.
Thanks to tough competition, loan products with offsets are now as cheap as those without. But not all offsets are created equal – so make sure yours ticks two important boxes:
- the offset account gives you a dollar-for-dollar reduction in your mortgage
- you get that reduction on the full amount you have sitting in the account.
Then prepare to get debt-free years early.
The Christmas gift that keeps on giving for a loved one – or yourself! As a launch special, Nicole is offering both The 12-Step Prosperity Plan and her unique online money makeover system for just $49.95, a 57 per cent discount on the first year. Pre-register now at TheMoneyMentorWay.com