Reduce interest

make your money work harder for you

How many of us have a home loan or a debt of some sort? Moreover, the interest rate we’re paying?

If you have cash sitting in your saving account, firstly congratulations, I am envious. However, are you making good use of that money? Well, it depends on what you mean by “good use” right? No I don’t mean spending that money on something you always wanted. What I mean is, is that money working hard to help you pay off your debts quicker?

Let say you currently have a home loan of $400K, you’re paying 8.5% interest. Interest is calculated daily, therefore the lower the balance of the loan, the less interest you’ll have to pay each month.

Let just say that you are one of the lucky few now a day to have a spare $50K lounging about in the saving account, you can earn anything between 1% to may 8% in interest. Not only is the interest you earn less than the interest you have to pay, the tax man wants a share of the interest you earned too. Thank you very much Mr tax man.

Well, the simplest and easiest thing to do is to throw that $50K into the loan and reduce the loan balance to $350K, now you’ll only pay interest on the $350K. In most circumstances this is perfectly fine, you can always take that money back out by way of a redraw option. However, not all loans have the redraw option, and some loan charge you $50 each redraw. Most professional packages should allow free redraw, so check your current loan see if you can do redraws for free otherwise it’s not worth it. However, redraws can be very restrictive and a lot harder to manage if you don’t have the right loan.

A more effective way of doing the same thing is by having an offset arrangement. Offsets are really simply, you basically have a home loan account that is linked to your saving account where the balance of the saving account is “offset” against the balance of the loan for interest calculation purposes. E.g.. In our example above, your loan balance is $400K, your saving account balance is 50K. The 50K is offset against the $400K, therefore you’ll only pay interest on $350K ($400K debt - $50K Deposit). That’s how an offset arrangement works.

Based on this example you are effectively earning a net after tax return of 8.5% on the $50K, nice. [Just in case you’re wondering, the money you have in the offset account (the saving account) is yours, so you can do whatever you want to do with it].

But wait, there’s more. With offsets you can do more to help you pay off the loan sooner. As mentioned, interest is calculated daily, and any credit balance in the offset account is offset against the loan amount. Therefore, the more money you have in the offset account, the lower the amount of interest you’ll have to pay.

A simple strategy is to have all your salary paid into the offset account. Avoid touch that money until you have to. Use a 55 day interest free credit card to pay for all expenses that can be put on the card. Oh by the way, when a card say 55 days, it doesn’t mean 55 days for each transaction, it’s 55 days from the day of the first transaction for that statement period. Therefore, to avoid paying interest, you have to clear all balances by the due day of each statement. With some credit card, if you don’t pay off the balance even just 1 cent, they’ll charge you interest from the day of the transaction! Sneaky bastards! So pay off your credit card every month before it’s due!

Effectively what you are doing here is taking advantage of the bank’s money to assist you reduce your loan interest. Consequently, you end up having all your income sitting in an offset account reducing your interest, while using the bank’s money (credit card) interest free to pay for your living expenses. When the credit card bill is due, just pay for it out of the offset account as per normal. Then start the cycle again for the next month. This will help you save thousands in interest and therefore pay off your loan a lot sooner. Oh just remembers that you have to clear the balance of the credit card, otherwise you will be paying 17% interest on the balance then it’s pointless doing all this.

Good luck and hope you’ll be debt free soon.