On his blog, Scott proposes a new type of credit card account. Essentially a debit card, with an interest free period attached to a savings account. It’s an interesting idea and one which anyone can put into place with a little discipline.

It prompted me to briefly explore our situation. We have a home loan with a bank that forces us to have credit cards. These cards have enormous limits which are a huge risk for us (we can easily tend to overspend!)

What we also have on offer is a 100% offset account. This works by calculating interest on your savings at the same rate as your loan. This interest is then notionally paid off your loan, reducing your monthly repayments. Let’s take this simple example:

  • $300,000 loan
  • 9% interest rate
  • 25 year loan period

In normal circumstances, you would be paying $2517.59 per month on this loan.

If you used your credit card to defer payment of all your bills, and had $5000 sitting in your offset account, your monthly payments would be $2475.63. Saving you $40 a month. Over the 25 year period of the loan, you would save almost $40,000 in interest payments and have your loan paid off a little over a year early.

It sounds like free money. The nice thing is that you don’t have to pay tax on this interest earnt (which is considered income) as you never actually get given it. It is automatically deducted off your loan payments tax free.

In contrast, were you to deposit this money in an interest bearing account at the same rate as your loan, here’s what would happen over 25 years:

  • $5000 deposit
  • 25 years
  • 9% interest
  • $47,425 earnt

Not a bad outcome. By saving this money in a compounding savings account, you end up slightly in front over 25 years. Of course, this doesn’t take into account any tax you would need to pay on that amount, nor the fact that is it quite difficult to find savings accounts paying an interest rate the same or higher than what you can borrow at.

For us, we use a little of both tactics. Offsetting our loan payments and using any savings generated to go into an interest earning account. Here’s an example:

Loan:

  • $300,000 loan @ 9% interest and 25 year term
  • $5000 in loan offset account
  • $40 saved each month in loan payments
  • $39,188 of interest payments avoided at the end of 25 years

Savings:

  • $40 deposit each month into a savings account
  • 9% interest rate (for the sake of simplicity)
  • $45,089 earnt at the end of 25 years

Even at 7% interest on your deposit, you end up with $32,500 saved.

Whether this is the best use of our money, I’m not sure. I haven’t spent too much thinking about it. But in practical terms for us, it works quite well.