Why Paying Off Your Investment Loan Could Be a Big Mistake

Paying off your investment property to retire on the rental income sounds like the ultimate dream, right? But what if that common financial goal was actually a big mistake?

This guide breaks down four crucial reasons why paying off your investment loan early could put you in a worse financial position and why using an offset account is almost always the smarter strategy.

What is an Offset Account? A Quick Refresher

First, the basics. An offset account is a regular transaction account that is linked directly to your investment loan. The magic is that any cash you hold in this account "offsets" your loan balance for interest calculation purposes.

For example, if you have a $500,000 investment loan and $500,000 in your offset account, the bank treats your loan balance as zero. You pay no interest, effectively achieving the same outcome as paying the loan off entirely. However, this method comes with powerful perks that simply paying it down doesn't offer.

Reason 1: Unbeatable Access and Flexibility

The single biggest advantage of an offset account is liquidity. The money in your offset account is 100% your cash. You can access it anytime for emergencies, investment opportunities, or lifestyle needs without asking the bank for permission.

• Emergency Fund: Cover unexpected repairs or medical bills.
• Major Purchases: Buy a car, fund a holiday, or pay for a child's wedding.
• Future Investments: Have cash ready to deploy for a new opportunity.

If you had used that cash to pay down the loan instead, it becomes locked away as equity in the property. Getting it back means applying to borrow again, which can be incredibly difficult in retirement when your income is lower.

⚠️ A Word of Warning on Redraw Facilities: Some people pay down their loan to use a redraw facility. However, a redraw is not the same as an offset. The bank can legally restrict or freeze your access to redrawn funds—a risk that became a reality for some borrowers during the COVID-19 pandemic. An offset account gives you complete control.

Reason 2: The Magic of Creating "Good" Debt

This is where things get really clever. Using an offset account can legally turn normally non-deductible personal debt into tax-deductible investment debt.

Let's say you take $50,000 from your offset account to buy a new car. That money is no longer offsetting your investment loan, so you will start paying interest on that $50,000 portion of the loan. Because the loan's original purpose was for the investment property, that interest is now tax-deductible.

However, if you had paid off the loan and then borrowed $50,000 against the property's equity to buy the car, the interest would not be tax-deductible because the purpose of that new loan is for personal use. The offset account preserves the loan's original investment purpose, giving you a huge tax advantage.

Reason 3: Unlock Powerful Tax Arbitrage Strategies

"Tax arbitrage" is a sophisticated term for a simple concept: legally moving money to benefit from differences in tax rates. An offset account makes this incredibly effective.

Imagine you have $100,000 in your offset. By moving it, you incur a tax-deductible interest cost, but you can create a much larger financial benefit for your family.

• Help Your Kids: You can lend the $100,000 to your child interest-free to put in their home loan offset account. You incur a small, after-tax cost on the deductible interest, but they save thousands in non-deductible interest on their mortgage—a massive financial head start for them.
• Benefit a Low-Income Spouse: You could invest that $100,000 in your low-income partner's name. They might earn investment income on it and pay little to no tax, while you get a tax deduction on the interest. As a couple, you come out significantly ahead.
• Use a Family Trust: You could lend the money to a discretionary family trust you control. The trust can then invest the money and distribute the income to a low-tax family member (like a university student), creating a tax-effective outcome for the entire family unit.

Reason 4: Gain Crucial Estate Planning Flexibility

When you have a property with a loan and cash in an offset, you effectively have two separate assets: the property (with its attached debt) and the cash. This separation can make estate planning much simpler and fairer.

Consider Tom, who has a $1 million investment property with a $500,000 loan and $500,000 in his offset. He has two children:

• Claire: Has a strong income and wants to keep the property as an investment.
• Emily: Is just starting her career and needs cash, not a mortgage.

If Tom had paid off the loan, he would only have one large, indivisible asset. But by keeping the cash in the offset, he has options. In his will, he can leave the property (with the loan) to Claire and the $500,000 in cash to Emily.

This flexibility allows him to meet both of their different financial needs perfectly, avoiding potential family disputes and ensuring his legacy is distributed exactly as he wishes.