How to save thousands in interest & pay off your home loan faster: How offsetting works
Yes, hello, Matthew Dawe, Mortgage Broker here. And I'm actually here with Jason Ferrone from US Tax Pros.
Matthew: Hi, Jason.
Jason: What's up, man? How's it going? Thanks for having me, man.
Matthew: Good, good. Nice to see you again.
Jason: Yes, yes. Good to see you too. These interest rates are stressing a whole bunch of us out, including myself. So, tell me more, man. What can you tell me about this?
Matthew: Yeah. Your question was, Jase, about potentially considering how do I pay off your loan faster, right?
Jason: That's the goal, isn't it?
Matthew: Yeah.
So, what I'm going to do is I'm going to show you a few strategies and how to do this. And hopefully everybody else gets some value out of this. So, just quickly, right? I'm going to cover off two strategies for paying off your loan faster, okay?
So, number one, it's called offsetting. How offsetting works is, I'm going to give you an example.
Let's just say, hypothetically, you had a $500,000 home loan. So, you got $500,000 home loan. Let's just say the payments are, let's say $4,000 a month. That is your total principal plus interest. That's your total payment. So out of that $4,000, this is just an example. Let's say $3,000 is interest. And let's just say $1,000 is principal. So that's how the payment is made up, okay? So, your total is $4,000 per month, okay?
Matthew: Pretty straightforward?
Jason: Still follow.
Matthew: Okay, awesome.
So, you've got your principal and interest, your normal payment, and you've got $3,000 worth of interest and $1,000 principal. Let's just say this is a 30-year home loan, okay? Very, very long. Very annoying, okay?
And people will say, well, how do I pay off my loan faster? This is just one of the strategies. Now let's say you were holding $250,000 in cash in a linked account. So, it could just be in a normal bank account linked to the loan. And quite often, this is obviously quite a bit of money. This is quite a bit of cash, but you might have $50,000 or $20,000 on offsetting. So, all it is, it just sits in an account. It's linked to your home loan.
Now, when you make your payment, you're still making a $4,000 a month payment, but you're only paying half the interest... see because you've got $250,000. So, you're only paying interest on $250,000, not $500,000.
Jason: Is that paid directly from that offset account?
Matthew: No. Well, you can do if you want, but it's just a normal home loan payment.
Jason: Got it. Okay.
Matthew: So, this interest part is only half. You can see here, right? And the reason is, because you have $500,000 home loan but you've got $250,000 in cash, right? Held in a link bank account. So, basically you're only paying interest on $250,000, because technically you only owe $250,000 because you could just pay it off at any time.
Jason: So, that $250,000 is available to pay off basically. So, it's not really tied to anything.
Matthew: No.
Jason: It's not like you're setting aside sort of GST for a little bit and then using that, right? It's nothing like that. It's just pure savings.
Matthew: It's just cash that you're not using. It could be $50,000, it could be $10,000.
So, just quickly on this point, right? Firstly, keep in mind that you saw that $3,000 interest, $1,000 principal at the top, giving you your total $4,000. You're still making a $4,000 a month payment, but a bigger proportion is principal because you're only paying half the interest. So, guess what happens? You end up paying off the loan much faster.
So, the positives equals paying off the loan faster, okay. Which is a really cool thing. The negatives are you need the cash, obviously have cash savings, but you're going to hold for a protracted period.
Jason, I think you mentioned this to me, but I'm similar. I've got a business as well. We need to hold cash because we've got employees. And if we have a quiet month or there's a few weeks between getting income into the business, we still need to pay salaries and all that sort of stuff. So, you need to hold cash always. So, you can actually utilise this cash to offset your home loan. If it's just dead money, right? Because you need the money always available, but it's not being used. It's just available at all times.
So, the negatives are, you obviously need that cash savings in particular for protracted period, right? So, I usually say to clients, if you're not going to be holding that cash for at least 2 years or at least 18 months, the offsetting is going to be negligible, right? Because it makes an impact if you hold that money for a long period because you're going to pay off your loan much faster.
Another negative is that offsetting is on the floating interest rate.
Jason: Oh, but you have to leave it at a floating interest rate.
Matthew: That's right. So, for any dollar that you're not offsetting up here, so in this case you had $250,000 cash, but you owe $500,000. So, on the extra $250,000 that's left, you're going to be paying floating interest rates, which are higher than fixed.
Jason: Got it.
Matthew: So, in this example, you would be better to have $250,000 fixed and $250,000 as an offset loan.
So, that's a negative to watch out for. The offsetting is obviously floating interest rates. So, you got to be careful with offsetting, just making sure you've got the cash. Yeah, so that's point number one.
Hopefully everybody followed how that works. Another negative is not offered by all banks, okay. And I'm not going to tell you which banks, but not every bank. Probably only really half the banks offer this product. It's just in their product makeup. Do they offer it or not? There's no other reason. Some banks specialise in it and it's a big part of what they do. Other banks don't do it, but they do other things. So that's option number one.
Matthew Dawe
Mortgage Broker | Financial Adviser
Phone: 027 321 4287
Email: mortgages@matthewdawe.com
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