Offset Account, Tax and High Rate Term Deposit/Saving Interest

Still in the cloud of Global Financial Crisis, some banks often offer very generous high interest rate for saving account or term deposit, even much higher than their mortgage interest rate. So, if you have mortgage as well, is it better put any extra money in this high interest saving or put it in the offset account of your home loan ? Here is the answer…

Interest: Saving higher than mortgage – a trick?

Normally, bank will offer a saving account or term deposit with interest rate less than their homeloan rate. Because this is fundamentally how a bank derive their profit (beside fee from service of course).

For example: a bank get $100 million term deposit and give customer $5million as interest with 5% rate, then they will give $100 million lending (i.e homeloan) with 6% interest and get $6million re-payment from homeloan customer and end-up they book  profit of $1 million.

But you will find sometime – for short period (“Today Only!” or “This Month only”-kind of thing) banks offer very generous interest rate for saving or term deposit account. Is this some kind of trick ? No, they are real…

Remember, for smart people: “If it seems too good to be true, check out first and don’t miss out” – only people with no knowledge and not smart will always say “if it is too good to be true, it usually it is” – do not follow them they are mediocre people that will be just that: mediocre – average.

So, the next question will be? Is it better off I put the extra money in this super high interest, or just keep it on the mortgage’s offset account ?

(btw, the reason bank offer such high interest is to lure people deposit their cash so they can boost their cash reserve/loan ratio.)

High Interest Saving vs Mortgage Offset Account

One tricky factor that need to be considered to make this comparison is the tax. As you know, income from earning interest from deposit or saving is taxable (I heard rumor that it won’t be in the future to encourage saving, but until it becomes law , this kind of interest is taxable)

So, let’s pretend we have $300,000 mortgage with 6.5% interest, and suddenly the bank (could be different bank) offer a high 8% interest online saving or term deposit. As you have $15,000 extra money (emergency cash) – will it better in offset account or in term deposit ? (Assuming your tax rate is 30%)

If you take high interest saving with 8% interest, you will get $1200 interest, with 30% tax rate this is reduced significantly to $840. With $300k home loan you will pay $19,500 interest on 6.5% rate, so in net you will have to pay $18,660 (less interest earned after tax).

If you just put money in the offset account, your mortgage is treated as $285,000 instead of $300k and “only” attracts $18,525 interest. Well, at the end still better than taking the high interest saving / term deposit (see table above for more detail comparison)

Of course, if the bank keep increasing the high interest saving account/term deposit, at some stage it will be more beneficial to take that instead of offset account. To calculate that threshold, just use the formula below the table (above).

At this stage the calculation will yield 9.29%. Meaning if the bank offer 9.30%p.a for term deposit/saving account then you will start to be better off taking that offer rather than leaving your extra money in the offset account.

The spreadsheet to use calculate above number (Just right click on the link and select ‘Save As’):
termVSoff.ods (Open Office’s Calc format)
termVSoff.xls (Microsoft Excel format)

Conclusion

If you want to take high interest saving/term deposit for your extra money, make sure the interest offered is higher than the threshold. Otherwise, leave it in your offset account.

Remember, One bad thing about term deposit is that you cannot take your money as you wish. In the case of emergency you will suffer a penalty to access your money.

I always  suggest to put your emergency money in account that do not restrict in when you want take it (such offset account or saving account) – although it quite prudent to have some handful under your pillow as well (not too much, though)!!

Good luck in making inform decision !

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• Offset Account: A Must Have For Your Mortgage