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Imagine I have two loans, one is 300k and the other is 50k.

I also have an offset account with 35k in it.

All income is going in to the offset account and so it should rise rapidly. If i offset the 50k then I will soon reach parity, thereby not paying interest on the smaller loan (I'm assuming I will still need to pay the principal).

But the interest savings will be greater if I offset the larger loan will it not?

Which loan should I offset to save myself the most money?

edits: Country is Australia, interest rate is 6.5% on both loans and monthly repayments are made on both loans approx $1800 and $400 a month.

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You need to give more information. Which country are you in? What are interest rates and the monthly payments on each loan? Or do you not have to make monthly payments at all? If you declare bankruptcy, are the loans then discharged? (Student loans in the USA are not discharged in bankruptcy, for example). –  Dilip Sarwate Jun 5 '12 at 2:10
    
Both loans are 6.5%? –  JoeTaxpayer Jun 5 '12 at 3:07
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2 Answers

if the rate of interest on both loans is 6.5%, it does not make any difference against which loan you offset. if you offset it with 50K loan, you will close it sooner [I am assuming your 50K loan is of shorter tenure compared to the 300K without considering offset].

The overall interest outgo looks larger if you close the shorter loan vs closing the larger loan, however the net effect is the same if you start putting out the balance $400 to the 300K loan after you have closed it out.

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An offset account is simply a savings account which is linked to a loan account. Instead of earning interest in the savings account and thus having to pay tax on the interest earned, it reduces the amount of interest you have to pay on the loan.

Example of a 100% offset account: Loan Amount $100,000, Offset Balance $20,000; you pay interest on the loan based on an effective $80,000 loan balance.

Example of a 50% offset account: Loan Account $100,000, Offset Balance $20,000; you pay interest on the loan based on an effective $90,000 loan balance.

The benefit of an offset account is that you can put all your income into it and use it to pay all your expenses. The more the funds in the offset account build up the less interest you will pay on your loan.

You are much better off having the offset account linked to the larger loan because once your funds in the offset increase over $50,000 you will not receive any further benefit if it is linked to the smaller loan. So by offsetting the larger loan you will end up saving the most money.

Also, something extra to think about, if you are paying interest only your loan balance will not change over the interest only period and your interest payments will get smaller and smaller as your offset account grows. On the other hand, if you are paying principle and interest then your loan balance will reduce much faster as your offset account increases. This is because with principle and interest you have a minimum amount to pay each month (made up of a portion of principle and a portion of interest). As the offset account grows you will be paying less interest, so a larger portion of the principle is paid off each month.

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Your answer teaches me that knowing the offset % would influence what is the best solution. –  Alex B Jun 6 '12 at 18:08
    
@AlexB, yes true. The offset accounts I have are all 100%. Most of the big lenders here offer 100% these days, some lenders in the past offerred less than 100%, but it is just something the consumer has to look out for and be aware of. As they say; 'the devil is in the detail'. –  Victor Jun 8 '12 at 3:24
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protected by Chris W. Rea Jan 21 '13 at 13:59

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