Offset vs Redraw. What's the deal?
We often hear the terms ‘offset account’ and ‘redraw’ bandied about, but what do they actually mean and how can they help you pay off you loan faster?
How an offset account works.
An offset account works like a high-interest savings account linked to your loan. The funds sitting in an offset account are saving you interest on a daily basis.
For example, if you have a $600,000 home loan and an offset account with a $50,000 balance, you will only be charged interest on $550,000 of your home loan. It is worth mentioning that while most lenders offer a 100% offset, some only offer a partial offset
Is important to note that your repayments will not change though; instead, the money saved will reduce your principle amount, which in turn, reduces your loan term. The more you have in the offset account, the less interest you pay on the mortgage. Over the life of the loan, the money you save on the interest, reduces the principal of the loan, thus paying off the loan quicker.
Your money generally works harder in a loan offset account compared to a regular savings account. That’s because the interest rate you pay on a home loan is usually higher than the interest you earn in a savings account.
Another advantage is that the interest you save by using an offset account won’t be considered income – which means it won’t be taxed. On the other hand, the interest you earn on a savings account will generally be considered income – and that means it may be taxed.
It’s important to note that offsets are generally only available with variable rate loans, although there are now a handful of lenders offering offsets with fixed loans too.
How a redraw facility works
A redraw facility is a home loan feature that allows you to make extra repayments directly into your loan. These payments will be pooled in a fund that you can withdraw anytime you need it.
Here's how it works: If you are only required to pay $1,500 monthly but you decide to pay $1,700, the extra $200 will go to your redraw facility. If you consistently pay $1,700 for five years, you will have made $18,000 worth of extra repayments. If your loan balance is $300,000 and you have $18,000 sitting in redraw, you will only pay interest on $282,000 (300,000 – 18,000 = $282,000If you decide to leave the funds untouched, a redraw facility will help you pay your loan faster. However, you can also withdraw the funds you have accumulated.
You can also make lump sum repayments toward your loan when you use your redraw facility. It will reduce the principal ahead of your regular repayment schedule.
Offset vs. redraw — is one better than the other?
These home-loan features are great additions and can help you save money. Each, however, has a slightly different way of helping you pay off your loan, but both allow you to pay off your loan faster.
Paying off your loan faster – which one is best?
Offset – Any funds sitting in your offset account act to reduce the interest payable on your loan. These interest savings reduce your principle loan amount.
Redraw – Any extra repayments you make above your normal repayments reduce the principle loan amount, therefore you are charged less interest as your loan balance is lower.
An offset is considered the most flexible option for paying off your loan sooner. It is handy to preserve your tax deductibility if you want to upgrade your family home and keep it as an investment. It is also handy if you want to utilise the funds for another purpose, such as for a new car etc.
A redraw facility may not be as flexible as an offset account. For example, you may not have the option to redraw money from an ATM or transact using a debit card. Some lenders may set minimum redraw amounts or you may incur a redraw fee each time you use it.
Tax implications are another concern. When you have an investment property and you bring the loan balance down through extra repayments, you might access those funds eventually through a redraw facility. Doing so would prevent you from claiming these extra repayments as tax deductions, unless you can demonstrate that use of these funds is still for investment purposes.Whereas if those funds were sitting in the offset account before, this 'fund purpose' test would not apply. The full loan balance is always tax deductible and
the money deposited in the account can be withdrawn at any time. This arrangement offers major tax advantages for borrowers to pay off owner-occupied properties (which don't offer tax deductions on interest) while still retaining access to the money. Mortgage offset accounts provide financial flexibility to homeowners
Taking advantage of offset and redraw
While these two home-loan features add convenience to your home-loan journey, you need to ensure that you are using them at their highest potential.
You should place funds into the offset account or loan account as frequently as possible. The earlier you have your funds sitting in your offset account or redraw facility, the better you can take advantage of the savings both provide. As interest is calculated daily on the loan, it is most beneficial to deposit your wages or any surplus funds into your loan account as soon as possible.
Borrowers need to take note, however, that these loan features come with costs.
An offset feature is generally a more expensive option, compared with a loan redraw feature. If the offset is part of a Package, then you need to decide whether the yearly fee (approximately $395) is worth it. If you want the benefits of an option of paying your loan off quicker but don’t want the flexibility that an offset provides then a basic home loan with redraw may be right for you. It’s also worth noting that basic home loans often come with a cheaper interest rate than loans with offsets and multiple loan splits/accounts.
We love to chat, so contact us today to discuss your finance and help you decide which option is right for you.
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