Understanding the difference between L.O.C and offset accounts

Many of the property investors I speak with are often confused about the differences between Line of Credit facilities and Offset Accounts.

Understanding how these two types of loan related products can function will help determine the best fit for your property investment strategy.

What is a Line of Credit?

A Line of Credit (often abbreviated to ‘LOC’) is a variable rate loan facility which is secured by a mortgage over a residential or commercial property.

Since a line of credit is secured by property, its credit limit can usually be much higher than a limit for a credit card, and the interest rate is generally a great deal lower.

Similarly to a credit card, a line of credit has an approved credit limit.

Funds can be readily accessed by debit card, cheque and internet and phone banking.

Interest is payable only on the funds drawn and it is possible with some line of credit products to capitalise the interest.

This means that repayments will not be required until the facility has been fully drawn, that is, the balance owing is equal to the approved credit limit.

In this way, a line of credit can offer great benefits in preserving or improving an investor’s cash flow position.  

Depending upon the credit limit and funds used, it may be some years before any repayments are due.

That’s why some property investors use a line of credit for their financial buffers for a rainy day.

Further, a line of credit can be established in anticipation of an investor’s next property purchase, whenever that may be. accruing, but funds are available ‘at call’.

Given that interest is only calculated on funds drawn, if there is a nil balance, there is no interest accruing, but funds are available ‘at call’.

Despite the benefits, lines of credit may not suit every investment strategy.

Depending upon the lender and whether or not the line of credit is included under a professional package, establishment and ongoing administrative fees can sometimes be higher than for term loans.

What is an Offset Account?

An Offset Account is a stand-alone transaction account that is specially linked to the loan. 

It can be a very effective tool in reducing loan interest and keeping funds separate for tax purposes.

Rather than earning interest on savings, the savings balance is theoretically deducted from the loan balance, which in turn, reduces the interest charged to the loan.

Another advantage is that the ATO does not consider this as earning interest income and so benefit is achieved without additional tax expense.

Further, an offset account can reduce the term of the loan and allows funds to be kept ‘at call’ and used for any purpose.

There are two different types of offset accounts:

100 percent offset – Every dollar in the transaction account is offset against the loan balance, working to reduce interest charges.

For example, if the offset account has a balance of $20,000 and the loan a balance of $200,000, loan interest is calculated on $180,000.

Partial offset –  A proportion of the transaction account balance is offset against the loan balance.

For example, where the offset account has a balance of $20,000, the loan a balance of $200,000 and there is a 40% offset capability, loan interest is calculated on a balance of $192,000.

Tax Implications

As with any component of an investment strategy it’s important to be well-informed before making any decisions.

Although funds in an offset account sit separately from the loan, there could be taxation matters to consider when converting a property from a principal place of residence to an investment property.

Consultation with a qualified taxation accountant will provide clarity in this regard.

Similarly, an experienced finance broker can provide valuable assistance in determining how lines of credit and/or offset accounts can be used to best advantage.