Why you might not want to pay off your home loan entirely

What is an offset account?

An offset account is a type of transaction account linked to your home loan, where the balance of the offset account is "offset" against the amount you owe on your mortgage. This means you only pay interest on the difference between your loan balance and the offset account balance. For example, if you have a $200,000 loan and $50,000 in your offset account, you’ll only be charged interest on $150,000.

There are two types of offset accounts:

• Full offset: The entire balance of the offset account is deducted from your home loan balance when calculating interest.
• Partial offset: Only a portion of the offset account balance is deducted from your home loan balance when calculating interest.

‍

Why you might not want to pay off your home loan early

Interest savings through offset accounts

The primary reason homeowners use an offset account instead of paying off their home loan entirely is the ability to reduce the amount of interest they pay. The more funds you have in your offset account, the less interest you’ll accrue on the principal of your mortgage. This can result in significant savings over the life of the loan without the need to completely pay off the mortgage.

For example, if you have $100,000 in an offset account linked to a $500,000 mortgage, you are only paying interest on $400,000. The savings on interest can add up quickly, especially over time, without the need to reduce the principal balance of your home loan.

‍

Liquidity and flexibility

One of the major advantages of using an offset account is the liquidity it offers. When you pay off your mortgage, the money is locked into the property and you can't access it easily. In contrast, money in an offset account is still available to you should you need it. If an unexpected expense arises or an opportunity to invest in something lucrative presents itself, you can quickly access the funds in your offset account.

This flexibility allows you to keep your financial options open. You can benefit from the interest savings of offsetting your loan, while still maintaining the freedom to access the funds when necessary.

‍

Tax benefits

In certain cases, particularly if you own an investment property or are running a business from home, there may be tax advantages to keeping your home loan in place. Interest paid on your mortgage can often be offset against other income for tax purposes if you are using the property for business or generating rental income.

If you use the funds in your offset account to make investments, it can be a way to balance your wealth generation strategy with your mortgage repayment goals. Additionally, keeping your mortgage in place while investing can help you preserve tax benefits such as depreciation.

‍

Potential to invest elsewhere for higher returns

Instead of using extra funds to pay down your mortgage, you could consider using the money in your offset account to invest in higher-return opportunities. For example, you might invest in the stock market, real estate, or a retirement fund that offers returns greater than the interest rate on your home loan.

In such cases, offsetting your home loan allows you to reduce the interest on your mortgage while still having the option to invest in assets that could provide a higher return than the mortgage interest rate. If you’re comfortable with taking on some level of risk and have a diversified investment portfolio, this could be a more financially rewarding strategy than paying off your home loan early.

‍

Inflation and low-interest rates

If inflation is high or interest rates on home loans are relatively low, paying off your mortgage quickly might not be the best use of your funds. With inflation increasing the cost of living, keeping your home loan at a low interest rate while offsetting the balance can help you retain more of your savings. By offsetting, you still reduce interest payments without committing to paying down the mortgage principal.

Additionally, if you have a low-interest mortgage, the cost of holding the debt might be less than the return you could earn by investing the funds elsewhere. This makes keeping your home loan and using an offset account a viable option, especially if your interest rate is significantly lower than potential returns on your investments.

‍

When should you pay off your home loan instead?

While offsetting your mortgage can be a smart financial move, there are situations where paying off your home loan early may make sense:

• If you are near retirement and want to reduce your financial obligations.
• If you have high-interest debt elsewhere and want to eliminate that burden first.
• If you want the peace of mind that comes with owning your home outright.
• If the interest on your mortgage is significantly higher than what you could earn by investing.

‍

For many homeowners, using an offset account to reduce the interest on their mortgage while maintaining flexibility and liquidity can be a more effective financial strategy than rushing to pay off the loan entirely. By offsetting, you can save on interest, keep your money accessible for emergencies or investments, and possibly generate better returns than what you’d save by paying off the loan early.

However, it’s important to consider your individual financial situation, your goals, and your risk tolerance before deciding whether to pay off your mortgage or offset it. Consulting with a financial advisor can help you weigh your options and choose the strategy that works best for your long-term financial health.