Has your lender offered an offset account or redraw facility as a home loan feature, but you aren't sure what they're all about?
They both have the potential to help you reduce the amount of interest you pay on your mortgage. But they work in different ways. So this could impact which is better for you.
Keep reading to learn what offset accounts and redraw facilities mean in Australia so you decide which is best for your personal circumstances.
What is an offset account?
An offset account is a regular transaction bank account, except that it's linked to your home loan.
What's the benefit?
The more money you put into your offset account, the less interest you pay on your mortgage. This is because whatever is in this account offsets your home loan balance, and you'll only pay interest on the difference.
With an offset account, you can:
- Reduce the interest (and overall amount) you pay on your home loan. Money deposited into this account offsets your mortgage balance, and you only pay interest on this difference.
- Pay off your loan faster as you're reducing your interest.
- Make deposits and withdrawals freely as needed. Just like a savings account, you can access your money through a debit card or ATM. You can use it to pay off credit card debt, renovate your home, or spend it on other emergency needs.
Other things to note about offset accounts:
- Note that money in this account doesn't actually go to paying down your mortgage balance. This means it won't help to reduce your monthly repayments.
- You won't earn interest on offset accounts like you would with a regular savings account.
- It may only be available on variable-rate home loans.
- There is usually a fee associated with offset accounts. So make sure that your interest savings will be more than this cost.
How an offset account works
Let's say you have a $500,000 mortgage and $50,000 in your offset account balance. You'll only need to pay interest on the remaining $450,000 instead of the full $500,000.
Pros and cons of an offset account
Pros:
- Lower your home loan interest payments by offsetting your offset account savings against your loan balance.
- Pay off your loan faster by reducing the overall mortgage amount.
- Flexibility and access to funds when needed. You can access this money just like you would with any transaction account.
Cons:
- May not always be available on all types of home loans. Some only offer offset accounts on home loans with variable interest rates.
- There may be extra fees in the form of a flat fee or higher interest rates.
- You do not earn interest on unused funds in offset accounts.
- Some lenders only offer partial offset accounts where only part of your offset account balance is subtracted from your home loan amount.
What is a redraw facility?
A redraw facility allows you to make extra home loan repayments on top of your regular fortnightly or monthly minimum repayment amount.
This lowers your home loan balance along with your interest payments.
The added benefit is that you can still access these extra payments if you need them in the future.
With a redraw facility, you can:
- Bring down your total loan amount with additional repayments.
- Lower your interest payments as you lower your loan balance.
- Access money in your redraw account in the future if you need it for emergencies or other uses.
- Pay off your loan in a shorter period of time.
Other things to note about redraw facilities:
- There's less flexibility when accessing funds in your redraw facility. Some lenders have minimum redraw amounts, and it could take longer to access these funds.
- You can make additional payments in regular smaller amounts or as a lump sum.
- Some lenders only offer redraw facilities on variable-rate home loans. In this case, you will need to wait till the end of your fixed-rate loan term before you can apply for a redraw facility.
How a redraw facility works
Let's say your minimum monthly repayment on your home loan is $1,000.
You choose to pay an extra $100 a month (going into your redraw facility). This adds up to $1,200 in a year.
The extra $1,200 will still be available for you to withdraw later. You can use it in emergencies or for other reasons like home renovations.
You'll also benefit from paying lower interest rates on your loan as you've reduced your loan balance.
Pros and Cons of redraw facilities
Pros:
- Reduce your overall debt as you make extra home loan repayments.
- Lower your interest payments as you pay off more than your minimum repayments.
- Still maintain access to the extra repayments if needed (e.g. in an emergency).
- Pay off your home loan faster!
Cons:
- Fees may apply when accessing the funds in your redraw facility account.
- There may be restrictions on how much money you can access in your redraw facility.
- May not be available on fixed-rate loans (this varies with each lender).
- Break costs may apply if you make additional payments over a certain amount.
What is the difference between an offset and a redraw facility?
While both of these options help you save on your home loan, they do have some key differences.
1. Structure
With an offset account, you can have a separate account where you can deposit extra funds, and the balance of this account is used to offset the interest on your mortgage. This lets you benefit from interest savings without actually bringing down your home loan balance.
On the other hand, a redraw facility allows you to make additional repayments on your total home loan balance. This means you're not only reducing the interest but the actual loan balance as well.
2. Flexibility
You can access money later from both your offset account and redraw facility if needed.
But withdrawing money from your redraw facility won't be as flexible.
You can access money in your offset account just like you would with a regular transaction account. You can nominate this account to receive your salary, access funds through an ATM, and use a linked debit card for payments.
With redraw facilities, it's not convenient for daily transactions (you won't have a debit card), and there may be restrictions on the amount you can redraw.
However, this could also be seen as a positive for some people who want to prevent themselves from taking out money for unnecessary spending.
3. Tax implications
If you decide to make your home an investment property, the interest charged on that loan would be tax deductible. This will not be so on a loan where the home is owner-occupied.
Let's say you made extra repayments through a redraw account while still living in it; this means the loan balance is smaller. As a result, you've also reduced the amount of debt that would qualify for tax deductions.
In such cases, an offset account might have been more beneficial.
It's best to speak to a financial planner if you plan on purchasing property for investment purposes. It could affect whether an offset account or redraw facility is better for you.
How do you set up an offset account or redraw facility?
Many Australian banks and lenders offer offset accounts and redraw facilities to their customers.
This applies to big banks or smaller, more specialised lenders.
Speak to your lender if you have any questions about setting up an offset account or redraw facility.
The lowdown: Is it better to have an offset account or a redraw facility?
Offset accounts and redraw facilities are both great options for diligent savers. But the best one for you will depend on your individual needs as a borrower.
If you're looking for flexibility and easy access to your funds, an offset account is likely your best bet.
However, if you're more focused on paying off your principal sum as quickly as possible, a redraw facility might be the way to go.
