redraw or offset? clarify my understanding.

I am looking at buying my 1st home for PPOR, and have looked at different home loan options and packages. The best rate I could find has NO offset account - only free redraw facility. The ones with offset account are of a higher interest rate. And I am trying to decide which option is most suitable - as the difference in rate is about 0.2% i.e. $800 based on a 400k loan.

Say I buy House A for PPOR with a 400k home loan. Over 5 years I pay off 60k principal and 40k "extra".

Scenario one - in 5 years I purchase House B as an IP using the 40k "extra" as deposit, and continue to live in House A.
Irrespective of whether that 40k was from a redraw or offset account, House B has full tax deductability.

Scenario two - in 5 years I purchase House B as an PPOR using the 40k "extra" as deposit, and House A becomes an IP.
IF I had a full offset account - the tax deductability is 400k-60k=340k.
IF I had a redraw account - the tax deductability is 400k-60k-40k = 300k.

Is this the correct understanding?

 

Scenario 1.
You would need to make sure you set up a separate loan to withdraw the $40k or you would end up with a mixed purpose loan. This would mean any further deposit into the loan would come off the investment portion as well as the non deductible portion.

Other than that you could probably claim the interest on the money used to buy IP1.

Scenario 2.
If you take the money from the offset you will be able to claim interest on teh $340k as this is associated with the purchase of the first property which is now a rental property.

It you took the $40k from redraw you would be borrowing it to buy a private item so the interest on this wouldn't be deductible. Since the loan was paid down to $300k then the deductible interest would be based on this amount.

But again if you just take $40k from redraw then you would end up with a mixed purpose loan - which may not matter so much if it was IO, but with a PI loan you would need to apportion each repayment between the deductible and non deductible.

What about scenario 3.
You start off with a $400k loan but take an IO loan with 100% offset. You end up paying $100,000 into the offset rather than the loan.

After 5 years you decide to buy a new PPOR and use the $100,000 for the deposit. You rent the old PPOR and claim interest on the full $400,000

This could give you about $7,000 pa extra in tax deductions. This is a lot of money over 30 years - think of the compounding effect.

 

Thank you Terryw for your advice.

Makes perfect sense to do it as an IO loan.

 

Caschit,
I agree with Terryw (as I normally do) in his summary.
Just adding to Terryw's comments on if you keep A as your PPOR and purchase B as the IP as in your first scenario.

In this case an offset or redraw is not critical as you should look to get the property A revalued and refinanced and set up a separate loan facility to fund the settlement of the purchase of B being an IP (with the majority loan from another lender). In that way you will have a 105% loan in effect which the interest expense is all claimable.

There are other posts discussing why you should use separate lenders.

My view is that an offset provides greater flexibility in the future than using simply a redraw facility as I have seen too many clients having gone down the redraw path to have their goals change and develop over time. If there is a possibility that your second scenario may happen, go with the offset.

I'm surprised that you have found such a difference in rates between offset and no offset, ignoring introductory rates, the best should only be about 0.1% on a variable rate product.
Good luck
Greg