Extra $100k on Top of The 20% Deposit. Should I Immediately Reduce The Mortgage or Park It in Offset Account?

donny donny on 07/10/2019 - 22:05
Last edited 08/10/2019 - 21:59

EDIT: kudos to redforever and Tbone74 who solved my queries with easy to follow explanation. You can find their comments in the thread.

Looking for financial gurus to share their 1 cent :)

i always thought that placing x$ in 100% offset account will save the same amount of interest as reducing x$ on the mortgage balance.

Please see the below example:

Deposit : 20%
Loan amount : $480,000
Terms : 30 years
Interest rate : 3.20 on both case (outside the scope for this thread's discussion)
Yearly fee : $100 on both case (outside the scope for this thread's discussion)
purpose : first home buyer but may look into other investment purchase in the future (outside the scope for this thread's discussion)

Case A: $100,000 in offset account since day 1 - which will bring down the duration of the mortgage by 5 years (according to ING & any other bank online offset calculator)
Case B: $0 in offset (redraw account), starting balance of $380,000

I know that interest rate and yearly fee for redraw account will be cheaper than offset account - not relevant for this thread's interest query.

Question: in terms of interest payment, would I be better of with case A, case B or both are equal?

Link to mortgage calculator: https://bit.ly/2ViWXoM (or google ING mortgage calculator)

I always thought that case A and case B are equally the same in terms of interest payment. However, after crunching all the number into the above online calculator, it seems that the interest payable is cheaper on case B.

Calculation on Case A
Loan Details
Loan Amount: $480,000.00
Loan Period: 30 year(s)
Interest Rate: 3.20 %
Offset Account Balance: $100,000.00
Offset Account started after: 0 year(s)

Results
Fortnightly Repayments : $957.67
Revised Term : 25 Years
Interest you could save: $125,219.78
Time you could save: 5 Years

Total repayments: $957.67 * 26 fortnights *25 years = $622,485.50 ($142,485.50 interest payable for the total loan)

Calculation on Case B
Loan Details
Loan Amount: $380,000.00
Loan Period: 30 year(s)
Interest Rate: 3.20 %
Offset Account Balance: $0.00
Offset Account started after: 0 year(s)

Results
Fortnightly Repayments : $758.16
Revised Term : 30 Years
Interest you could save: $0.00
Time you could save: Less than 1 Month

Total repayments: $758.16 * 26 fortnights * 30 years = $591,364.80 ($211,364.80 interest payable for the total loan)

Can anyone explain why case A is not equal to case B? doesn't placing money into the offset account is giving the same impact (on interest) with paying off the principal? so technically, case A should be the same on case B ?

Financial

Comments

  • Earl of Lemongrab on 07/10/2019 - 22:08

    Maybe the ING calculator is wrong?

  • donny donny on 07/10/2019 - 22:19

    Just tested NAB calculator with the exact some result… :(

    https://www.nab.com.au/personal/home-loans/calculators/loan-…

  • cloudy on 07/10/2019 - 22:26
    +1

    It’s because at the end of the 25 years you still own the 100k in the offset.

    So you “Pay” 30k more, but you keep 100k in 25 years time.

    In other words, A = paid 480k loan
    B = paid a 380k loan

    Me thinks, I’m not 100% sure though.

    • donny donny on 07/10/2019 - 23:08

      Yes, but the 100k still belongs to the bank and need to be paid to them at the end of the loan..

      • cloudy on 08/10/2019 - 09:48

        Like I said, I’m not 100% sure, but I do believe you are right in assuming that having a 380k loan and a 480k loan with 100k in offset the whole time means you end up paying the same amount of interest over time.

        Assuming all things equal. If not, something is wrong.

        But do let me know if I am right, I haven’t bothered with the maths itself, been too long ago did I study this.

        • donny donny on 08/10/2019 - 21:57

          Yes, you are right, the calculation is explained below by redforever and Tbone74

  • asdffdsa on 07/10/2019 - 22:27

    In case B, your fortnightly repayments are lower/your term is longer. If your term is the same, you will have the same results.

    • donny donny on 07/10/2019 - 23:09

      the term in case A is 5 years shorter as there is no more repayment to pay after 25 years :)

  • tbone74 on 07/10/2019 - 22:42
    +2

    For case B you're calculating your total interest based on $480k loan, but it's only $380k. Interest payable is (591,364.80 - 380,000.00) $211,364.80.

    • donny donny on 07/10/2019 - 23:11

      This is correct, but at the end of the day, the 100k in offset account belongs to the bank.. so i should have calculated as follows:

      $242,485.50 total interest on case A and $211,364.80 total interest on case B?

      • tbone74 on 07/10/2019 - 23:19
        +4

        No, the 100k is your money you already have before obtaining the loan (in addition to the deposit, etc).

        With that 100k available, you can choose plan A which is to park the 100k in an offset account, reducing the interest. Total interest over the (now reduced) 25 year loan is ~$142k.

        Or you can choose plan B which is to increase your deposit and reduce the loan size. Total interest over the 30 year loan is ~$211k. If you increase payments (reduce loan term) to match plan A, the interest would then also be ~$142k.

        • donny donny on 07/10/2019 - 23:40

          So after the now reduced 25 year loan, the 100k is mine and not the bank? just like what cloudy has mentioned above?

          I have entered the number for 380k at 25 years

          Loan Amount: $380,000.00
          Loan Period: 25 year(s)
          Interest Rate: 3.20 %
          Offset Account Balance: $0.00
          Offset Account started after: 0 year(s)

          Results
          Fortnightly Repayments : $849.65
          Revised Term : 25 Years
          Interest you could save: $0.00
          Time you could save: Less than 1 Month

          $849.65 x 26 fortnight x 25 years = $552,272.50 (172k interest)

          • redforever on 07/10/2019 - 23:50

            @donny donny: just re do your calculation for case B. How did you calculate the total interest payable?

            Using ING calculator, the total interest payable is $211,364.80.

            In case B, you actually stop paying interest after 20 years as the principal owing falls below your offset. so you pay 70k less in total interest in case A.

            • donny donny on 07/10/2019 - 23:55

              @redforever: For case B, i wont have any more money to put into the offset account as i placed the whole $100k extra to reduce the principal on day 1…

              • redforever on 08/10/2019 - 00:04
                +1

                @donny donny: That's correct. and the total repayment for borrowing 380k over 30 years at 3.2% is 591,364.80

                The total interest payable is 591364.8 - 380000 = 211364.8

                You made a simple subtraction mistake in your calculation in your post.

                • donny donny on 08/10/2019 - 00:09

                  @redforever: Fixed the post, thank you :)

                  However, doesn't placing money into the offset account should give the same impact (on interest) with paying off the principal? so technically, case A should be the same on case B ?

                  • redforever on 08/10/2019 - 00:16
                    +3

                    @donny donny: it should be. take another look at the ing offset calculator for case A. look at the yearly breakdown table.

                    After 21 years, the principal owing falls below 100k (which is your offset amount). from then on, you no longer pay any interest. you can do the calculation, 100% of the repayments after year 21 goes into reducing the principal.

                    So to compare the 2 cases, case B should be change to 21 years term because after 21 years, you could have paid off the loan in full using yoir offset.

                  • tbone74 on 08/10/2019 - 00:56
                    +3

                    @donny donny: The reply from redforever explains this but wanted to add to help make it clear.

                    Assuming payments are per the schedule, the total interest paid is a result of the time it takes to reach the point where you have zero net debt (remaining loan minus offset). So in my previous post where I said for plan B you need to increase the payments (reduce loan term), the target should be to match the payments, not the loan term.

                    As redforever already mentioned, that means for plan B you actually need to change it to ~21 years. With 21 years in the calculator it should give (approximately) the same $957 payment and ~$142k interest in total.

                    And yes, the 100k offset is your money. That is true before and after the loan. A simplified example might help.

                    Let's say somebody wanted to buy a $600k property. Forget the stamp duty and other costs just for this example. If you have $220k in savings, and want to pay a minimum 20% deposit to avoid mortgage insurance, you could:

                    A - pay $120k deposit (20%) and borrow $480k. The remaining $100k can be place in the offset account, meaning you don't need to pay 3.2% interest on that $100k - you're only paying interest on $380k. That's better than the alternative of putting the $100k in a savings account which returns less interest (and is taxable income).

                    B - pay $220k deposit (~37%) and borrow $380k. You're again paying interest on $380k, so it's the same net result, assuming you're making the same payments. But because it's a smaller loan, the minimum payments would be lower. If you stick to those lower payments, you'll end up with higher net debt and higher total interest.

                    For plan B, the costs associated with that type of account can be lower, as I believe you're already aware. Besides that, the primary benefit of putting more savings in to the initial deposit instead of in an offset account is it reduces your minimum payments because of smaller loan size. That in turn can increase your borrowing capacity, which is calculated based on your capacity to cover the minimum payments.

      • redforever on 07/10/2019 - 23:35

        In your calculation for case B above, you total repayment is 591364.80, this is the total repayment for borrowing 380000, so your interest paid in this case is 211364, compared to 142485 for case A. So you save about 70k in interest. This is because you are taking an extra 5 years to pay off the loan.

  • bcarp on 07/10/2019 - 22:45

    If you are ever thinking of renting this house as an investment property, even for just a few years, then A is better. Talk to your financial planner/accountant about why this is. Complicated & probably outside the scope of this discussion.

    If you want to have another loan for something else in the short-medium term, then B may be better, but would depend on your LVR & capacity to service the loan. Again, talk to your financial planner/accountant.

    If all other things are equal, then A is better as having a higher loan amount gives you more leverage with the bank to negotiate an individualised discounted home loan rate.

    • donny donny on 07/10/2019 - 23:17

      All other things are equal i believe, at least at this stage.. Would the 100k differences gives me much leverage? i was thinking that borrowing too much would possess greater risk to the bank. Banks have told me that i can borrow roughly 550k-580k ish

      • bcarp on 07/10/2019 - 23:22

        I don't know if 380k vs 480k makes enough of a difference to the bank. You'd have to talk to them directly. It's likely the trigger for the next stage of discounted rates is a round number, like 500k or 1m, I think, but this is still an increase of the loan amount be about 25%. Getting an accountant or financial planner involved is probably a good idea to give up to date advice on these things.

  • garetz on 07/10/2019 - 22:54

    Get a government calculator, and input the variables yourself.

    I wouldnt trust a calculator provided by the loan provider themselves.

  • Woodinski on 07/10/2019 - 23:33
    +3

    Mortgages typically have a fixed repayment per month. This is based on the term of the loan and the assumption that you have nothing in an offset/redraw account. In the case above the reason that Case A repayment is about 20% larger than the Case B repayment is because the total loan amount is 20% more.

    With Case A you are making repayments on a larger mortgage ($480,000), with the assumption there is nothin in the offset account. The fact that you have money in the offset means that you pay less interest on each mortgage repayment, and therefore the monthly repayment contains a larger component of "principal being repaid (equal to the amount you save in interest"from the offset account). This should be reflected by your mortgage account slowly becoming positive overtime (if it has a redraw linked to the account, if not will just reduce faster). This additional amount of principal being repaid is the reason that your loan gets paid off 5 years quicker.

    • donny donny on 07/10/2019 - 23:58

      yes, the loan on case A is larger than case B. but doesn't placing money into the offset account give the same impact (on interest) with paying off the principal? so technically, case A should be the same on case B ?

      • MatthewSoul on 08/10/2019 - 01:53

        He's right. The repayment amount is higher when you use an offset account compared to paying the loan off.
        In both cases you still owe the bank 380k but with offset it forces you to repay a larger monthly amount hence paying off your principal quicker.
        Always go with offset account for flexibility.

        • John Kimble on 08/10/2019 - 02:06

          Always go with offset account for flexibility.

          Never say always :p

          Some people don't want flexibility.

  • f38r1 on 08/10/2019 - 07:40

    Everyone seems to miss the obvious.

    Case A you could take the money and use it anytime when you need it.

    Case B you can't.

    Simple.

    • tbone74 on 08/10/2019 - 10:42
      +3

      Yes that's obvious and I don't think anybody missed it. Rather you missed the question being asked by OP, which was solely about trying to understand how the numbers work.

  • Skramit on 08/10/2019 - 08:37
    +4

    OP the "interest payable" over the life of the loan would be the same, therefore netting you the same overall loan cost. The problem you are seeing is with the calculators and the way you are trying to use them. For your comparison you need a custom calculator.

    Your inputs into scenario A and scenario B are misleading you. Both should have a loan size of 480k. Then on day 2 of Scenario A you would factor in 100k in the offset which reduces your total interest payable. Then day 2 of scenario B you would reduce the loan balance by 100k to give you the same result.

    Ultimately both scenarios you described will net you the same result, however the calculators are not set up to handle this type of comparison.

    OP would you like a copy of my mortgage calculation spreadsheet which is? :)

    EDIT: I've done up the 3 scenarios for you in the spreadsheet.

    A - Offset 100k, 480k loan
    B - No offset 480k loan with 100k paid off the loan on Day 1
    C - No Offset 380k Loan.

    A - Total cost of loan $523k
    B - Total cost of loan $523k
    C - Total cost of loan $593k

    C is higher cost only because you're taking the full 30 years to pay it off, and the repayments are much lower than scenario B. Scenario B is essentially a 380k loan but paying almost 500 extra per month which nets you the massive saving over C.

    In summary, scenario A is easily the best as it has the best flexibility from a daily use POV with offset account and the saving is identical to paying a lump sum off the loan of 100k on day 1.

  • backpaqer on 08/10/2019 - 16:28
    +1

    I'd go the offset option as it gives you the flexibility of access to ready funds should you need them. If you go the other way without offset, your mortgage choices increase to open up options for non-bank lenders and potentially even cheaper rates.

    (I have a substantial offset account… Works for me).

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