Offset account vs redraw facility – which is best?
While home loan rates ultimately tell you how competitive a home-loan offer is, it is still important to check for handy features that could help you pay off your home loan faster, like offset accounts and redraw facilities.
These two home loan features allow you to use extra funds to reduce the amount of interest you pay. This means that if you are a meticulous saver, you could benefit the most from these features.
But which is the better way to manage your mortgage and minimise interest payments: redraw or offset?
We chat to our Member Relationship Manager, Lauren Murray to find out.
Well firstly we should probably explain how a redraw facility and an offset account work.
With a redraw facility you can make additional payments to reduce the outstanding balance of your mortgage, which in turn reduces the amount of interest you pay. However, those additional repayments are not locked away – you can redraw on them at some point in the future. If you withdraw any of your repayments this will increase your loan balance, so you’ll pay more interest.
An offset account works more like your day-to-day bank account. However, the balance of the offset account is subtracted from the outstanding balance of your mortgage, and you only pay interest on this difference.
For example, if you have a $300,000 loan with $20,000 in offset, you are only charged interest on $280,000. It’s the same as if you have a $300,000 loan and transfer $20,000 into the loan, your balance would be $280,000 and that's what interest is charged on. But the difference with an offset account is that you'd have the $20,000 available to use whenever you needed.
For many homeowners it won’t make a huge difference. The offset account is a bit more convenient as all your cash is working to reduce the outstanding loan amount on which interest is calculated.
The redraw facility may require a bit more active decision making in terms of how much to pay off or redraw and when. Some banks also set minimum redraw amounts or may charge fees on each withdrawal. On the plus side, the extra effort involved with a redraw facility can provide an element of discipline for people tempted to dip a bit too readily into the available funds in the offset account.
If you are borrowing to invest, however, choosing between redraw and offset can have a significant impact on your tax bill.
Imagine you buy an investment property and have a loan of $500,000. The interest on this loan is tax deductible. You then receive a windfall that allows you to pay off $100,000, leaving a loan balance of $400,000. Soon afterwards you redraw $50,000 to splurge on a new car. The loan jumps to $450,000, but as the redraw is for personal use the loan amount attributable to the investment property remains at $400,000. You won’t be able to claim a tax deduction for the interest on the $50,000 redraw. What you will likely end up with is a headache from trying to manage the personal and investment components of the loan as future repayments or redraws are made.
Now imagine that you deposited your extra $100,000 into your offset account. The bank subtracts this from your loan balance of $500,000 and only charges you interest on the $400,000 difference. The crucial difference is the loan amount is still $500,000 and all attributable to the investment property. The withdrawal of $50,000 from your offset account is unrelated to the investment arrangement. Yes, you’ll pay interest on the full loan amount of $450,000, but it will remain fully tax-deductible.
Even if you are not a current investor but there’s a chance your existing home may turn into a future investment property, the same principle applies. This is where it could get very tricky, and we’d suggest you talk to a qualified financial planner.
Provided you have the discipline to manage your offset account, it should give you more flexibility than a redraw facility and could potentially save you costly tax issues. But ultimately your decision should be based on your own financial needs and goals.
This article is intended as general information only and has been prepared without considering the personal financial situation, objectives or needs of the reader. Before acting on this information, you should consider its appropriateness, having regard to your objectives, financial situation and needs.