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I am refinancing a variable rate mortgage (current rates are low and expected to fall further in the next 12 months - currently 4.25%).

I have a cash sum equivalent to about 20% of the full loan amount.

My options are

  • to place the cash in an at-call mortgage offset. This account pays no interest but for interest calculation purposes reduces my loan amount dollar for dollar.
  • to place the cash in a term deposit (current rate is 3.05%pa). This would not be at call but for security I could stagger the deposits so that a portion of the cash is available every month or so.

This money is my safety net in case of illness/unemployment and I do not need/want regular access to it. I have 25 years until retirement.

I am confused because online calculators seem to imply that the term deposit is best long term (20+years) but the conventional advice is that mortgage offset is the way to go. The bank financial advisor recommends the offset for tax reasons (I would pay no tax on half of the interest from the term deposit, 30% on the second half). I don't know where to start in making this decision. Any advice is appreciated.

  • I have a bias towards paying off debt, if the trade off isn't substantial. So considering you will pay a higher rate on your mortgage then you earn on your deposit using the first option seem the way to go. I am assuming there aren't tax benefits included. current rates are low and expected to fall further That isn't a sure condition, so don't count on it to happen. – DumbCoder May 16 '16 at 15:21
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The offset account is the way to go. The rate is higher and even if interest rates fall further when you go to renew your term deposit the interest rate for that will be lower as well. Also, with a term deposit you will be penalised if you take the money out before the end of the term.

Regarding tax, you will pay tax at your marginal tax rate on every dollar earned from the Term deposit ( as long as your income is above the $18,000 tax free threshold). If the mortgage is for your primary residence then you will not pay any tax on the money in your Offset Account, as you are not earning any interest in this account you are saving interest on your mortgage.

So definitely the way to go would be with the offset account, you'll get an effective higher interest rate, it will help you pay off your mortgage sooner, the money is always on call, and you will pay no tax.

  • Thankyou Victor. I wrote the tax info poorly, I only pay tax on half because it is jointly held and one party is under the tax free threshold. Family Tax benefit complicates this further though in ways I can't explain (or understand!) It seems like a no-brainer the way you put it. I think the calculator came out the other way because near the end of the loan term the return on my offset diminishes. That would be a nice problem to have (ie more in the offset than owing on the loan!) I only worked this out tonight. Hope someone else finds this Q helpful as well. – Maree May 17 '16 at 12:19
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    If you start having more money in the offset than the amount of the mortgage then you can just take out any excess and place it in a high interest online account which would give similar interest rate to a term deposit except the money is at call. You would just pay tax on any interest earned from this account. – Victor May 17 '16 at 21:30

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