There’s a good chance we’ll get another interest rate rise at the next rates announcement on November 3. And if you’re juggling two jobs, school drop-offs, a mortgage and maybe one investment property, this news will probably land with a familiar thud.
I’m of the opinion that I can’t control what the Reserve Bank does, but I can control how I respond to it.
So, with this in mind, here are the two moves I make every time we’re in a high interest rate environment, and why they might help save your household thousands of dollars a year.
I pay down my home loan instead of using an offset account
The offset account is one of the banks’ best marketing tools. The sales pitch sounds great … you only pay interest on the difference between your home loan balance and the money sitting in your offset account. Your savings work for you, and you can still get to them whenever you like.
And yet, there’s a catch you should be aware of.
Offset accounts usually come bundled into premium ‘package’ loans, which often carry a slightly higher rate, typically around 0.1–0.3% – which is the equivalent of one RBA rate rise – plus an annual fee of a few hundred dollars.
The bigger cost is that the convenience keeps people loyal to a bank whose rate may sit well above the sharpest deals in the market. That’s the con hiding inside the convenience; You end up paying the bank extra for the privilege of letting it use your savings.
Compare that with putting your savings straight onto the loan and keeping access through redraw if there comes a time that you need it. The money still reduces the interest you pay, and you can still access it in an emergency, but you’re not paying a premium rate to do so.
Now, there are two things to weigh before you go down the redraw path. First, redraw isn’t guaranteed. Banks can reduce or freeze access to it, so it’s wise to keep a separate emergency buffer you know you can always reach.
Secondly, think about whether your home could become an investment property one day. Money you redraw counts as new borrowing for tax purposes, so the interest on it is only deductible if you use it to earn income.
Money in an offset never touches the loan, so the full original balance stays deductible if the home is rented out. If you think you might upgrade and rent out your current home, make sure you speak to your accountant first, because in that case an offset may be worth paying for.
The gap between a typical big-bank rate and the sharpest rates in the market can easily be 0.5%, and that adds up faster than most people think.
On a $700,000 mortgage, the gap between 6.5% and 6% is roughly $225 a month in minimum repayments. If you take the lower rate but keep paying what you would have paid at 6.5%, you could be mortgage-free close to four years sooner.
For a family with young kids, that’s four years of your income back before they’ve even finished school.
Plenty of lenders offer sharp rates on loans without the bells and whistles, including the online-only banks. If you’d rather stick with a bigger name, Macquarie has some of the most aggressive home loan rates in the market.
Some lenders even offer an offset at no extra rate, so if you do want one, make sure you’re not paying a premium for it.
The bigger lesson is this … just because rates go up doesn’t mean you have to pay more than you need to. If your bank isn’t giving you a good enough deal, consider taking your business elsewhere.
I set up a tax variation
Most people let the government hold onto their tax money all year, interest-free, and then celebrate when a refund lands post-June. In a low-rate world, that’s not a big deal. In a high-rate world, I want that money in my own account, paying down my home loan from day one.
If you’re not sure how tax refunds and variations work, I’m happy to give you a simple example.
Say I earn $250,000 a year. On that income I pay roughly $80,000 in tax.
Now say my investment property makes a $40,000 loss for the year. Around $20,000 of that is real money out of my pocket, and the other $20,000 is a paper cost in the form of depreciation.
I can offset that loss against my income, so instead of paying tax on $250,000, I only pay tax on $210,000. Because I’m in the top tax bracket, that works out to close to $20,000 less tax.
Normally, you’d get that $20,000 back as a refund at the end of the financial year. But the ATO lets you apply for what’s called a PAYG withholding variation. Instead of waiting for a lump sum, your employer simply withholds less tax from each pay throughout the year.
That’s an extra $1,600 or so a month flowing into your account, and straight onto your mortgage.
One important warning though, make sure you talk to your accountant before you lodge a variation. If you over-estimate your losses, you’ll end up with a tax bill at the end of the financial year instead of a refund, and that’s the opposite of what you want.
Neither of these moves is complicated. Refusing to pay a premium for an offset account and getting your tax money working for you during the year are two simple ways to take back some power over your household mortgage.
In a high-interest, high-inflation environment, together they can save you thousands of dollars every year.
Rates will go up and down, and grocery prices will keep doing what they do, but you should never forget that you have the power to control where your money goes.
Not the government, not the supermarkets, and not the Reserve Bank of Australia.
