BASIC VARIABLE VS STANDARD VARIABLE HOME LOAN

REDRAW VS OFFSET

A basic variable loan (BVR) comes with a redraw facility where surplus funds can be deposited to the loan account. As an example, HSBC's basic variable loan marketed as Home Value starts from 3.55% with no ongoing fees.  

A standard variable loan (SVR) comes with both redraw plus offset facility. The borrower is given the option to deposit funds into an everyday account linked to the mortgage for offset purpose. For example, HSBC's standard variable marketed as Premier variable starts from 3.65% with $35/month fee 

Which is the better way to manage your mortgage and minimise cost: BVR with redraw or SVR with both redraw and offset?

1.

Owner-occupier in same property for life

No difference between the two products except for convenience. The loan account associated with a BVR loan is usually like an online account where funds have to be transferred to an everyday account before use. The offset account, on the other hand, is fully transactional.  If highly rate sensitive, the cheaper BVR loan can be nominated.

2. 

Owner-occupier with possibility of turning property into future investment property

Choose an SVR loan. Choosing the cheaper BVR loan may have adverse tax implication when the property is switched to investment use. Imagine you have a $500,000 mortgage and you pay off the loan in full. There is no mortgage to tax deduct against when the property is switched to investment use. 

For an SVR loan, in contrast, you will have a $500,000 mortgage with $500,000 in the offset account. No interest is payable even though $500,000 is owed technically. When the property is switched to investment use and the $500,000 in the offset account is used to fund your next purchase, you can claim a tax deduction on interest accrued from the $500,000 mortgage. Assuming 5.00% interest rate, a taxable income of $87,001 - $180,000 with the highest marginal tax rate of 37%, the tax benefit may equate to $9,250 per annum indefinitely.

3.

Investors with no owner-occupied mortgage

Choose an SVR loan. Choosing the BVR loan and using redraw can have a significant impact on your tax bill.

Imagine you have a $500,000 investment mortgage. A $100,000 inheritance is provided which you deposit directly into the BVR loan account. Soon afterwards you redraw $50,000 to get married. The loan jumps to $450,000, but as the redraw is for personal use, only interest accrued from $400,000 is tax deductible. The ATO looks at the purpose of the borrowing and not the security used as collateral when determining tax deductions. The investment loan account which was formerly fully tax deductible has effectively been "tainted".

For an SVR loan, the withdrawal of $50,000 from the offset account is unrelated to the investment mortgage and adverse tax ramification would not have occurred. Assuming 5.00% interest rate, a taxable income of $87,001 - $180,000 with the highest marginal tax rate of 37%, the tax benefit loss without an offset account for the $50,000 withdrawn may equate to $925 per annum indefinitely.

Conclusion

The single most important flaw a borrower can make when choosing a home loan product is being fixated on the cheapest interest rate without factoring the tax implication of having a home loan. If the household's objective is to repay a mortgage with no plans to upgrade or purchase an investment property, a basic variable with redraw facility may be adequate. For all other scenarios, a standard variable loan with offset facility must be considered. This perhaps explains why more than 60% of all home loans taken out in Australia is a standard variable loan with 100% offset facility.

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