Mortgage negatives are really positives

Bruce Brammall, The West Australian, 25 March 2024

In the big wide world of investing, there is nothing that discriminates between investors quite like cash.

No, I’m not talking about how much of it one person has over the next person. (Some will say that’s discrimination, but this column isn’t going into the weeds on class warfare today.)

I’m talking about returns on a dollar. The same dollar held by wealthy and poor investors alike. And, to a lesser degree, high- and low-income earners.

The discrimination is not to do with wealth, or income. It is actually to do with whether the cash investor has something else.

And that something is “negative cash”, also known as a home loan. And the discrimination is this: People with a negative cash position get a better return on their cash than people who have a positive cash position (ie, no debt).

Barking mad?

“Are you barking mad? People with loans are paying interest!”

Fair call to ask that question, and a question I am regularly asked by Mrs DebtMan for other reasons, but no, I’m not.

I’m talking about offset/redraw accounts attached to home loans. People with home loans get a far better return on their cash than those without a home loan.

And the higher interest rates go, the bigger the disparity gets.

How much better? Depending on your income, about twice as good, possibly three or four times.

Bang for buck

Let’s start with what we’re comparing – a savings account and an offset account, the latter of which is only available to those with a home loan.

What is an offset account? It’s a savings account attached to your home loan. Any savings you have in the account is netted off against what you owe on your home loan, before interest is charged.

If you have a home loan of $500,000 and you have $50,000 in savings (on average, over the month), then you only pay interest on $450,000 for the month.

If your interest rate is 6.2 per cent, that $50,000 has saved you $258.33. Over a year, $3100. That is a tax-free return. You don’t pay tax on money saved.

Versus taxable income

Now, the same money in a savings account. I’m going to use the Bank of Queensland “Simple Saver” account, which pays 4.85 per cent. Yes, there are plenty of accounts that pay a higher interest rate, but they have conditions on them, such as low maximum savings, bonus periods, minimum contributions or limited withdrawals.

If you have $50,000 in a savings account earning 4.85 per cent, you’ll earn $202.08 a month, or $2425 for a year.

But not what you get to keep. That is taxable income.

The highest income earners (47 per cent marginal tax rate) get to keep $1285.25 after tax. Those earning the average wage will have $1588.38 after tax.

Better returns

We’ve been pretty fair to savers with that interest rate, which most Australians will not be earning on their cash. And we’ve used an achievable, but fairly low, mortgage rate.

However, too many Australians have their savings in accounts earning a pitiful interest rate and the returns on their savings, after tax, would be woeful.

The $3100 “saved” interest is nearly 2.5 times as good as interest earned for the top marginal taxpayer and nearly twice as good for those on the average income.

Some financial commentators argue against offset accounts – that you should use savings accounts, possibly many of them, each with a different purpose.

And if that works for you to help you hit savings targets, think about money differently, help you spend less, then all power to that way of thinking and good luck with it.

For those who have control of their spending and are natural savers – and of course have an offset account – then the after-tax return you make from offsets are, on average, twice as good.

You don’t see the return, but it means you’ll pay off your home loan faster. Having $50,000 in your offset account on a $500,000 loan will see your home loan paid off five years and seven months early and save you $206,000 in interest (at 6.2 per cent).

And yes, it’s seems a bit discriminatory. The best returns on cash go to those with a home loan.

Another advantage of home ownership? Sure, but you’ve still got the debt to repay.

Bruce Brammall is the author of Mortgages Made Easy and is both a financial adviser and mortgage broker. E: bruce@brucebrammallfinancial.com.au.