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The principal component of payments would still lose deductibility, though it's true you'd retain deductibility for "extra" payments. Imagine a scenario where you take out a $300K loan, deposit into accounts the equivalent of P&I repayments until your net debt is reduced to $250K, and then...

Actually, LOC is for "line of credit", which is a loan which acts like a big credit card, secured against a home. The balance can go up and down anywhere within the limit (such as 80% of the property's value), provided deposits equivalent to at least the month's interest charges are made each...

Because if you pay down principal, and later need to access those funds for private purposes, you've lost deductibility on that sum, whereas if the funds are in an offset instead, then you retain deductibility. Of course, if you use a LOC rather than P&I, you've not gained any benefit.