What are offset and redraw facilities, and how do they differ?
Introduction
Whether you buy a new home or refinance an existing mortgage, you will come across the terms offset and redraw facilities. These two features are commonly found with variable-rate home loans and offer different ways to save on interest and pay off your loan faster. Though both can help you save money, they work differently and serve various purposes.
In this blog, we will discuss the meaning of offset accounts and redraw facilities, explore their unique benefits and differences, and help you choose the one that best suits your financial planning and goals. Understanding these features can make a big difference in managing your home loan effectively and save you a lot of money over time.
Key takeaways
- Offset accounts and redraw facilities offer ways to save on interest and pay off home loans faster.
- An offset account reduces interest by offsetting savings against the loan balance.
- A redraw facility allows borrowers to access extra repayments made on their home loan.
- Tax implication varies for offset accounts and redraws facilities.
- Speak to a financial advisor or mortgage broker for personalised advice on which option suits your needs better.
What is an offset account?
An offset account is a savings or transaction account linked to your home loan. The balance in this account is used to 'offset' against the outstanding balance of your home loan before interest is calculated. This means you pay interest on a reduced amount and, consequently, can achieve significant savings on the interest expenses associated with your mortgage.
Example:
Let's say you have a home loan of $400,000 with an interest rate of 4% per annum over 25 years. If you were to maintain $20,000 in your offset account throughout the loan period, your interest calculations would be based on a principal of $380,000 instead of the total $400,000. By doing so, you would save approximately $43,939 in interest payments over the life of the loan.
This setup benefits you in two significant ways: First, it reduces the interest you pay each month because interest is charged on a lower principal amount. Second, because you're paying less interest, more of your payment goes towards reducing the principal balance of your loan each month than would be the case without the offset account. As a result, the overall interest you pay over the life of the loan decreases, and you can pay off your mortgage faster.
What is a redraw facility?
A redraw facility is a feature available on home loans that allows borrowers to access and withdraw any extra repayments they've made over and above the minimum required payments. This functionality provides flexibility and access to funds valuable for various expenses, from emergency costs to planned purchases or investments.
Example:
Let’s say you have a home loan with a minimum monthly repayment of $1,000. If you pay an additional $100 monthly over a year, you would have made an extra $1,200 in repayments. With a redraw facility, you could access this $1,200 if needed for any purpose, such as making home improvements, funding a holiday, or covering unexpected expenses.
Offset V/S Redraw: What’s the difference?
Both offset and redraw facilities are beneficial home loan features that can help you save money and repay your loan faster. However, there are some critical differences between the two that you should be aware of before deciding which one is right for you. The table below shows some of the main differences between offset and redraw facilities to consider:
| Offset account v/s redraw facilities | ||||
|---|---|---|---|---|
| Points of difference | Offset account | Redraw facilities | ||
| What is it? | A separate transaction account linked to your home loan. | A feature attached to your home loan that allows you to withdraw extra repayments. | ||
| How does it help you save money? | Reduces the interest payable on the loan balance by offsetting it with the account balance. | The redraw facility lets you pay more than your required loan installment. This directly decreases the total loan amount (principal) and reduces the interest you owe over time. | ||
| Which type of home loan offers it? | Mostly found in variable home loans (but not all) and a much smaller proportion of fixed-rate loans. | Nearly all variable-rate home loans offer this feature. It is less common in fixed loans. | ||
| How can you withdraw/spend funds? | The same way you would use any other transaction account, for example, by making payments with a debit card. | You can withdraw funds from a redraw facility via online banking, making a phone call, or visiting your lender in person | ||
| Is there a maximum amount you can withdraw? | No, you can withdraw any amount up to the account's current balance. | Some lenders let you withdraw almost all your extra payments minus a small amount required to cover the next payment. While others limit how much you can withdraw to up to 80%. | ||
| No. of times you can withdraw funds | You can make unlimited withdrawals from your offset account as long as the account remains linked to your home loan. | The number of times you can redraw funds depends on your lender and home loan agreement. Some may have restrictions on how often you can access funds or charge a fee for each withdrawal beyond a certain limit. | ||
| Benefits | The main benefit of an offset account is the significant savings on interest payments and the potential to pay off your mortgage faster. Additionally, an offset account provides the convenience of having all your finances in one place, thus making it easier to track and manage your money. | The primary benefit of a redraw facility is its flexibility. By allowing you to access extra funds as needed, a redraw facility can help you cover unexpected expenses and save on interest by using those funds to pay off your loan sooner. | ||
| Drawbacks | The main drawback of an offset account is that it may come with higher fees or interest rates than other home loan types. Additionally, the money in your offset account may not earn any interest, unlike a regular savings account | One potential drawback of a redraw facility is that there may be restrictions on how much and how often you can withdraw funds. | ||
Tax Implications of redraw facility and offset account
Let’s now learn the tax implications of having a redraw facility or an offset account attached to your home loan:
Tax implications of redraw facility
When you use a redraw facility, each redraw is considered a new loan from a tax perspective. The tax deductibility of the interest on these redrawn amounts depends on what you use the funds for.
For example, if you redraw to fund a personal purchase (like a car or home renovation), the interest on that redrawn amount is not tax-deductible because these expenses do not generate income. However, the interest may become deductible if you've turned your house into an investment property and redraw it to fund another income-producing property.
Tax implications of an offset account
Offset accounts have a different tax treatment. The presence of an offset account and the withdrawal of funds do not change the nature of the original loan. Hence, there's no creation of a new loan for tax purposes. The interest deductibility remains based on the original use of the loan. The interest remains tax-deductible if the loan is for purchasing an income-producing property.
It's always best to consult a tax professional for more personalised advice on the tax implications of using an offset or redraw facility.
Offset vs Redraw: Which is a better option?
The decision between opting for a redraw facility or an offset account isn't about which is superior but rather about finding the right fit for your unique financial situation. Each option serves different economic strategies and preferences, and their availability may vary depending on the specifics of your home loan.
For instance, while redraw facilities are commonly available and can be activated on many types of home loans, offset accounts may not be as universally offered. They could come with additional costs or higher interest rates.
A redraw facility could be appealing for individuals who are diligent about making extra repayments on their home loan and occasionally find themselves with spare cash. This option allows you the flexibility to access these extra funds if needed, though doing so could diminish the interest savings you've accumulated by making those additional payments.
On the other hand, if having immediate access to your funds is a priority, particularly for managing day-to-day finances and ensuring your salary and bill payments are streamlined through one account, an offset account could be the better choice.
There are potential tax differences when choosing between an offset account and a redraw facility. If you're considering renting out your home as an investment property, the interest on your mortgage might be tax-deductible. In this case, using an offset account could lower your interest payments and lead to tax benefits.
On the other hand, if you aim to pay off your home loan quickly without investment plans, the redraw facility might be more suitable, as it generally doesn't have tax implications. It's important to align your choice with your financial objectives and consult a tax professional for tailored advice.
Can both offset accounts and redraw facilities be used together?
Yes, you can use redraw and offset facilities with your home loan. This arrangement provides benefits, including interest savings and flexible access to extra funds. Let’s understand this concept better with an example below:
Example:
Let’s consider you pay an additional $200 monthly for your home loan via a redraw facility. Over a year, this adds up to $2,400 in extra payments that reduce the principal amount of your loan faster and save on interest. You can withdraw this extra amount through the redraw facility if an unexpected need arises.
If you have $30,000 in your offset account, this sum is used to offset the balance of your home loan when calculating interest. So, if your loan balance is $500,000, the interest will be calculated on $470,000 instead, as the $30,000 in the offset account effectively reduces the amount on which interest is charged. This combination of extra repayments and offsetting can lead to significant savings on interest payments and help you pay off your loan sooner.
Eager to maximise these benefits? ZedPlus is here to help! With our access to a large panel of lenders, we can help you find a home loan that offers both redraw and offset facilities at competitive rates. This way, you can enjoy the benefits of both options and have the flexibility to manage your finances according to your needs.
Wrap up!
Offset and redraw facilities can be beneficial options for managing your home loan. Still, it's best to consider your individual needs and consult with a financial professional before deciding on your best choice. At ZedPlus, we specialise in helping you make the most informed decision between these options. Our approach is straightforward: we listen to your needs, analyse your financial situation, and then, with our in-depth knowledge of the current market, we suggest the most beneficial solution.
Also, as a qualified tax agent, we are well-positioned to provide guidance on the tax implications of offset accounts and redraw facilities. This ensures you have all the necessary information to make an informed decision and maximise your financial benefits. So, whether you use a redraw facility, opt for an offset account, or combine both options, we are here to support you every step towards achieving your financial goals. So, why wait? Reach out to ZedPlus today, and let us confidently help you navigate your options.
