Debt Recycling and the Offset Fallacy

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A common miss-conception that caught me out for longer than I want to admit is the difference in 'making money' and 'no longer spending money'.

When you use your offset you are 'no longer spending money', however I mistakenly thought of it as 'making money'. This meant I often miss-calculated investing while I have a mortgage.

Credit Card

Think of your credit card. If you spend $1,000 you start paying interest. If you repay the $1,000 you stop paying interest.

Now the question, are you saving 20% pa x $1,000 forever by paying off the credit card? How do we account for the interest we no longer pay because we paid the credit card off? 

I ignore it, and this applies to my offset too.



The Offset Fallacy

The example that made me see offsets differently was to imagine my current situation, lets say I've got a $200K mortgage with $100K in the offset. Now imagine you are debt free, and go and borrow $200K, park $100K in the offset and spend $100K on a nice holiday. Is the $100K in the offset your money? You just borrowed it from the bank, its the banks money. But wait, that's my current situation, and the offset is MY money... isn't it? How can that be, the same situation, but in one case its the banks money, and in the other its mine. What is going on.

And this is the Offset Fallacy. A mental fault we make where we think the offset is our cash, when the reality is we owe it to the bank.

I now view my offset as the banks money. Its a cheap credit card with an 'Available Credit' of what ever the balance is.

My offset is reducing my level of debt, while keeping it available to be spent borrowed again.

My offset is reducing my leverage.

Should I keep reducing my leverage?

HISA

When we compare the offset to HISA the offset is the winner. The key is to see it as reducing debt, not as a HISA on steroids.

An offset is equivalent to making 6% tax free on a HISA. But it isn't actually making 6% tax free.

But why does any of this matter?

Debt Recycling: Have your cake and eat it to

This miss-conception flows into another that took me far to long to realise. When you debt recycle you get to have your cake and eat it too.

You keep the benefit of the offset (reducing non-deductible interest bearing debt) while getting to invest with debt. You do lose access to that money  credit, so certainly don't debt recycle cash credit you need in the future.

But the key fact is I get to keep my 6% tax free return that I got from my offset, while also getting to invest with debt.

If you still don't believe me, here is an example:

An Example

Think of your mortgage as having 2 buckets.

  • Non Deductible = Interest Bearing Non Deductible Debt.
  • Deductible = Interest Bearing Tax Deductible Debt.

So Jane has $300k mortgage with $100K in the offset. She allocates $100k for the emergency fund. 

  • Mortgage = $300k
  • Non Deductible = $200K
  • Deductible: $0

Now Jane gets $100K inheritance and parks it in the offset.

  • Mortgage: $300k
  • Non Deductible: $100K
  • Deductible: $0

Putting money into the offset reduces her non deducible debt by $100K.

Now Jane debt recycles into shares. She splits the mortgage from $300K into $200K + $100K and moves the $100K from the offset into Mortgage 2, then redraws directly to a new brokerage account.

  • Mortgage 1: $200k
  • Mortgage 2: $100k
  • Non Deductible: $100K
  • Deductible: $100k

Non Deducible debt is still $100K, it has not increased. So the benefit we received from the offset (reducing non deducible debt) remains. 

Summary

So when calculating the cost to debt recycle, please don't be me and fall for the Offset Fallacy.

If you hear yourself saying "I need to beat the 6% tax free offset", pause and re-think what you just said.

So I should debt recycle?

Not so fast. Just make sure you make the decision with a better understanding. And have a read of this:

Should I debt recycle or leave my money in the offset? - Passive Investing Australia

Conspiracy Theory

I quite like this quote from DebtRecyclingAU aka Financial Advisor Kyle Frost on Reddit

The existence of offset accounts also changes the way people think.... 
My conspiracy theory is offset accounts were pitched to the banks by a McKinsey genius in the early 2000's as a Trojan horse to save people interest but keep them in debt longer as changes the way we think about debt.


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