Help! Our family is outgrowing our home, how do we afford a new one?

Hi Nicole, We are fast growing out of our home, but it has the potential to rent easily due to its location. Are we better off paying down our current loan, or should we just put as much possible into offset accounts to use that money as a deposit to buy a bigger house? Where I’m confused is if you own that home and rent it out, you’re gaining money from rent, so you don’t get the tax benefit side of it. Then, if you go one further, you end up with two mortgages – one for rental, one for the home you are in. It seems complicated, and I don’t know how to tackle a five-to-seven-year plan to get us into a bigger house. Thank you, Kelly

Not many readers will expect me to say this Kelly, but there is a smarter strategy than paying off your mortgage right now which, in five to seven years, could allow you to both upsize and retain your current home as a tax-effective investment property.

There is a smarter strategy than paying off your mortgage which could allow you to both upsize and retain your current home as an investment property.Credit: Fairfax Media

Essentially, you can keep the taxman at bay by ‘repaying’ it in a special way. The key, as you suspect, is the offset account.

The first thing you need to know is that any savings you hold in offset accounts – you might be able to hook up to a dozen individually named offset accounts to your loan – are netted off your loan balance.

The interest saving should be identical to paying this money directly into your loan. But do ask your lender whether the money is offset dollar for dollar and whether it is at an identical interest rate. Fixed-rate loans, for example, may offer only a partial offset account.

The second vital piece of information is that although offset accounts are hooked to a mortgage, they are quarantined from it.

But, again, you need to check. Only authorised deposit-taking institutions can offer offset accounts that are truly separate from a mortgage – which is imperative for three reasons (and why this column only ever highlights loans from such institutions).

1. Safety. In the fine print of most loans is the ability to block redraws – on which you would be relying if you instead deposited spare cash into your loan itself – should you get into financial strife.

What’s more, at least two lenders have in the past ‘recalculated’ borrowers’ outstanding loan balances and overnight sucked up money that may have been simply ‘parked’ in a loan to save interest. Indeed, this money could well have been intended for an emergency financial buffer, but then be lost to you. Hardly the point!

2. The future. You are very canny to be projecting ahead – many people fail to do this. And though you are doing it because you can see the walls closing in around your presumably growing family, it’s something everyone should do.

Using an offset account protects your family, gives you ultimate flexibility and sets you up for the future and building your asset base.

What if you were transferred overseas? What if you decided to take a year off work? The extra money you save could be deployed not just for a deposit on your next home, but for any number of curveballs or opportunities life may throw at you, provided you retain access to it.

3. Tax. Most people start small in property as it’s clever not to over-commit. Most people then throw every extra dollar they can into their loan.

Here’s the thing: that means, month after month, that property is becoming more useless to you as a potential investment. You can only claim tax deductions for interest on your lowest-ever loan balance. You would have little choice but to sell your original property. When you instead put these overpayments in a genuinely quarantined offset account, your loan balance does not ever technically fall, it is only deemed to. Your potential tax deductions – and rental property – are preserved.

In short, using an offset account protects your family, gives you ultimate flexibility and sets you up for the future and building your asset base.

So you are bang on the money Kelly. And hopefully, be in the money after five to seven years of diligent saving.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

Nicole Pedersen-McKinnon is the author of How to Get Mortgage-Free Like Me. Follow Nicole on Facebook, Twitter or Instagram.

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