When hunting for the best home loan deal, it's essential to not overlook the extra features that your lender may be offering. You may notice that your lenders offer either offset accounts or redraw facilities on home loans.
While beneficial, you're probably left thinking: what's the difference between these two features, and which one is better?
The simple answer is that the best feature depends on your financial wants and needs. However, we're here to delve deeper into the redraw vs offset debate so you can better understand which feature is more suitable for you.
What is an Offset Account?
Offset accounts are a type of transaction account that can knock off years from your repayments, helping you settle on your mortgage faster than expected. This home loan feature functions similar to a high-interest savings account.
Home loans that offer offset accounts as a feature comes in two forms for you to select from, these being:
- 100% (or ‘full’) offset accounts: This decreases the interest on your home loan by 100% of your account balance. The feature is typically offered for variable or fixed-rate home loans.
- Partial offset accounts: Instead of a 100% offset on your home loan, your mortgage is only decreased by part of your account balance. Therefore, you can save more money from your payable interest if the percentage of your offset account is higher. Typically, borrowers with fixed-rate mortgages retain more frequently. So you’ll have around just 40% deducted from the principal of the loan rather than 100%.
How Does an Offset Account Work?
Any cash that you place in your offset account will deduct your total interest payments on your mortgage. As a result, you won’t be charged your entire loan balance. Instead, the more you have in your offset account, the less you pay in interest.
For example, if your offset account has $100,000 and is fully linked to your $900,000 home loan, you would only pay interest on $800,000 of the balance.
Benefits of Offset Account
There are a range of benefits that you can enjoy with an offset account, these include:
- Offset accounts are not considered a taxable form of income: Unlike typical savings accounts, offset accounts don't earn any interest and cannot be taxed by the ATO. To find out how you can benefit from different tax implications on your offset account, consider contacting a professional for financial advice.
- Save money on interest: The more money you have in your offset account, the less interest you can pay on your repayments.
- Faster mortgage settlement: As a result of the money saved on interest, you can make large contributions to your home loan more regularly, consequently allowing you to settle faster.
- Easy fee-free withdrawals: The money you put into the offset account is unconditionally yours. You can take cash out at any time with zero questions asked, often with no withdrawal fees.
Limitations of Offset Account
However, some limitations are associated with offset accounts.
Such disadvantages include:
- Additional fees on home loan: While offset accounts may save you money by avoiding transaction or withdrawal fees, you can expect additional charges from your lender for having an offset account. Generally, you can expect to pay around $400 in annual fees for having an offset account linked to your home loan.
- Higher interest rates: Lenders may also charge you higher interest rates on your home loan. Consequently, despite having an offset account, this can result in you paying even more interest on your mortgage repayments. Ensure you carefully check the terms of your loan agreement.
Therefore, it's important to note that this feature may only be beneficial when you have a significant sum of money attached to your mortgage via an offset account.
What is a Redraw Facility?
A redraw facility is a feature that allows you to withdraw money from the excess balance on your home loan. While an offset account is separate from your mortgage, a redraw facility is located within your mortgage.
By making multiple additional payments with a redraw facility, you can potentially settle your loan faster with the benefit of accessing that money again when you need it.
How Does Redraw Work?
To properly use a redraw facility, you must make your repayments earlier than scheduled. Therefore, this allows you to utilise your extra funds to implement bonus loan repayments.
As a result, this method reduces your debt and interest.
Benefits of Redrawing
Similar to offset accounts, redraw facilities offer a range of advantages that you can benefit from.
Of these include:
- Reduction in total interest on your loan: With more money parked in your home loan, you will subsequently pay less interest on your mortgage repayments.
- Faster mortgage settlement: As redraw facilities encourage you to make additional payments on your home loan, you may never need to withdraw any money. Therefore, you can settle much faster on your mortgage.
- Flexible withdrawals: Redraw facilities provide you with the flexibility to access your cash in the event of an emergency.
Limitations of Redrawing
However, redraw facilities have some limitations that may persuade you not to use the home loan feature.
- Redraw facilities may not be available for fixed-rate loans: Similar to offset accounts, lenders may not grant you access to redraw facilities. If the lender allows the redraw feature, they may charge you redraw fees or have a predetermined limit on free redraws each year.
- Extra fees: Some lenders may also charge annual fees and withdrawal fees. Therefore, if you never redraw on your home loan, you would be paying for a useless feature.
- Your extra repayments are not considered savings: Lenders will treat them as repayments and, therefore, their money. In return, using your redraw feature is simply the lender allowing you to use their money.
- Withdrawal limits: As the lender considers your extra contributions their money, they can exercise more control over your withdrawals limits. Therefore it's not uncommon to find lenders that set minimum or maximum withdrawal amounts.
- Slower wait times on withdrawals: While offset accounts commonly offer same-day withdrawals, you can expect to wait 1 to 2 business days for your request to be processed and approved.
An essential consideration is that the additional money invested into your home loan repayments reduces the total interest. Therefore, when you redraw money from the excess on your home loan, you will consequently pay more interest.
Differences Between Offset and Redraw
When looking at offset accounts and redraw facilities, you can see that they share a common idea: they encourage you to invest any additional funds you have to reduce the overall balance of your loan. Subsequently, both an offset account or redraw facility help reduce the amount you pay on interest, saving you thousands of dollars on your loan.
However, while redraw facilities and offset accounts both work toward the same goal, their methods vary in some manners:
1. The money placed in your offset account is separate from your loan. Meanwhile, investing extra money into your mortgage with a redraw facility is directly paid toward the loan principal.
2. The money you put in your redraw facility does not belong to you anymore once handed to the bank. Whereas the cash you place into your offset account is something you still wholly possess, you can use the money to pay bills, withdraw cash at an ATM or day to day spending.
3. Redraw facilities have more restrictions than offset accounts. Where offset accounts can grant you greater freedom to access your funds, redraw facilities make the process slower and more expensive.
Therefore, despite their commonality, these two features have significant differences. So, which option is best for you?
Should I Use an Offset Account or a Redraw facility?
When picking between offset vs redraw, the decision simply comes down to your financial situation and how you manage your money.
For example, an offset account is an excellent option for those who consider themselves much more responsible with their money and spending habits. This is because they can invest their money into the account without the temptation of using the funds on unnecessary purchases.
Meanwhile, suppose you struggle with managing your finances and have spontaneous spending habits. In that case, the redraw facility will be more suitable. The administrative procedures and fees associated with redraw facilities can help discourage you from accessing the money. Therefore your funds can securely be stored in your loan and help reduce interest payments.
Finding the Best Option
Selecting the right home loan feature that suits your financial wants and needs may seem like a daunting choice, prompting several questions: Should you choose just one? Could you even utilise both? Which one is best for me?
To help you better understand where each feature thrives, here's a range of scenarios that effectively utilise either an offset account, redraw facility or both.
Scenario 1: Using an Offset Account
You just purchased a property and, because you're a great saver, you decide to open an offset account. Having borrowed $600,000 from the bank, you're keen to reduce your interest payments to help save money in the future, so you place $30,000 in your offset account.
As a result, that $30,000 gets deducted from the $600,000 you borrowed, only charging you interest on the remaining home loan balance ($570,000).
To further reduce your total interest payments, you can ask your employer to place your salary in the offset account. Instead of using your salary for expenses, you use a credit card to fund day to day spending, ensuring you pay your monthly bills on time.
Due to your ability to manage your finances effectively, your salary contributions steadily increase the size of your offset account. The only withdrawals made should be from your monthly credit card bill, which shouldn't exceed your ability to grow your savings.
In return, you can enjoy paying progressively less interest on your home loan and help save yourself thousands of dollars.
Scenario 2: Using a Redraw Facility
Hypothetically speaking, you consider yourself a little too liberal with your spending. You recently purchased a property and took out a home loan for $500,000. While you love your new property, you think a pool would be a great addition to the house. However, you cannot invest in such a purchase due to your current finances.
To save for your new pool, you decide to invest an additional $15,0000 in mortgage repayments for 5 years into a redraw facility. You've selected the redraw facility because you know you're unlikely to touch that money, as it is helping you reduce the charged interest on your repayments.
Flash forward, and you now have $75,000 secured in a redraw facility. As a result, you're only paying interest on $425,000 of your home loan, saving considerable amounts of money. At this point in time, you can decide whether you want to withdraw this cash to invest in your dream pool or, alternatively, leave the money to enjoy the reduced interest.
Scenario 3: Using an Offset Account and Redraw Facility
After purchasing your first home, you have found a lender that simultaneously offers a redraw facility and an offset account. After reviewing your ability to stay on top of your finances, you take out a mortgage for $850,000.
Because you have some extra cash available, you set aside $50,000 in an offset account linked to your mortgage and commit yourself to contribute $10,000 per year in additional payments for 5 years.
Although this is a large financial obligation, after 5 years, you now only have to pay interest on $750,000 of your home loan. You can also enjoy the tax benefits from having an offset account and the security knowing that you have accessible money safely secured in your home loan.
Finding the Best Home Loan with Joust
At the end of the day, when it comes to saving money on your home loan, it's essential to find a lender with the best rates and features. To empower you, the homebuyer, Joust Live Auction puts your home loan on an online auction for lenders to bid for.
In return, you can find the best competitive rates with enticing features across multiple lenders. Ultimately helping you find the right path to settling faster and saving thousands in potential interest charged by lenders.
Is it bad to redraw on a loan?
Restrictions on the minimum amount you withdraw may apply with some lenders. It's essential to keep a lookout for the most reasonable lenders, preventing any of these limitations from occurring.
How does redraw reduce interest?
Whatever money you put in your redraw facility will be the amount you aren’t charged interest on, reducing payments overall.
Can I get an offset account or redraw facility if I have a fixed rate home loan?
You can get a partial offset account if you have a fixed rate home loan, but it’s best to research what lenders offer this home loan feature.
Can I get an offset account or redraw facility when I refinance?
You can get either of these features when you refinance, but there are risks. Here is more information on refinancing to see if this option is right for you.