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We all want to get rid of that debt and be financially free as soon as possible… But is debt all that bad? Isn’t it possible to use debt to get rid of it faster?

Well, financial discipline and smartly structured loans can actually turn being in debt into lesser of an evil.

Since ages, principal and interest (PI) repayment loans have been the first choice of most borrowers, only because they are not well advised about the advantages of having an interest only loan with an offset account.

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Why people think principle and interest is better?

Lily plans to borrow $500,000 at a rate of 5% that she has to repay over a term of 25 years. If she decides to go for an interest only loan for the first five years, it means she will make monthly repayments of $1,250 for the first five years, and $1,980 for the subsequent 20 years. However, if she opts for a PI loan, her monthly repayments would be $1,754 and the cost of the loan over 25 years would be $24,037 lesser than the interest only loan.

Of course, Lily decides that it is wiser to go for a PI loan. How will she budget the increased repayments after 5 years and why should she pay $24,037 extra to the bank?

However, Lily’s mortgage advisor advises her differently.

Now imagine Lily opens an offset account linked to her interest only loan. She makes a repayment of $1,250 every month and deposits $750 in her offset account every month. In 5 years, she saves $45,000 in her offset account and in actual terms, her debt has come down to $455,000 and she has $45,000 in her account that will save her interest throughout the term and also cut down years from her loan.

How does an offset account work?

An offset account is like a regular savings account where you can save your extra money. The money in the account is offset against your loan, and you only pay interest on the difference, on a daily basis.

In the example above, Lily took a loan of $500,000. If she has $20,000 in her offset account, she only pays interest on $480,000 instead of the full loan amount.

Why should you save in an offset account instead of reducing your debt with a PI loan?

In the most simplest of terms, for better financial freedom!

In a PI loan, the bank tells you how much you should pay each month. This amount becomes a rut and even if you could pay more, you would refrain and stay indebted for the full term. Exactly what the banks want!

However, with an interest only loan, you only pay the interest on your loan, while putting away all your savings and extra money in an offset account. This not only brings down the amount of interest you pay, it is also building you a lump sum that you could use for an additional repayment later or invest in another property without potentially losing out on the tax benefits on your present loan – triple whammy, isn’t it?

Lily’s friend Sam had borrowed $350,000 for 25 years at a rate of 5%. He chose an interest only loan and over the period of time, by accumulating all his principal repayments and addition funds in an offset account, he currently has $200,000 sitting in his offset account.

This means that Sam is only paying interest on the remaining $150,000 and has $200,000 in his offset account as a lump sum.

Sam has decided to rent out his property and buy another house. So what does he do?

Sam is aware that once you pay off a portion of your debt, you cannot redraw on the loan and claim tax benefit unless the amount is used for investment purposes. However, Sam’s money is in an offset account, it was never really used to make any repayments against the loan and he can use this money to bring down his non-deductible PPOR (Principal Place of Residence) loan for his new residence by $200,000.

This move also gives him the benefit of tax deductions as his previous debt of $350,000 is restored to its original amount and being an investment property now, he can claim full tax deductions for the interest paid on the loan.

The final choice stays with you – if you can exercise financial discipline and get advice from expert mortgage brokers, interest only loans can really boost your finances. However, if you choose to be conservative and don’t want to play around with your debt, go for a Principal and Interest repayments home loan and read here for some handy tips to reduce your mortgage faster.

Whether you are considering interest only with offset or principal and interest loan, we have every type of
Home Loan Deals  to help you.

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