Offset vs Redraw: which one is best for you?

Let’s be clear, both can save you money on your interest payable, and both can potentially reduce your loan term if used correctly. What else do they have in common? They both give you access to your excess or extra repayments. So, what’s the difference? Well, that’s up to you. Each have their place, depending on your needs and objectives.

Why an Offset account?

An offset account works very much the same as an everyday bank account or high-interest earning account, which is linked to your mortgage. You can get access to your funds at any time, and some lenders will also provide you a debit/access card for additional convenience. However, rather than earning you interest (like the high interest account), an offset account saves you interest on your mortgage, the more you have in your offset account, the more you end up savings in interest payable to the lender.

Let’s compare a very simple example, $20,000 in a high interest account earning you 1.5% p.a. in interest vs an offset account (with the same amount) linked to a home loan with an interest rate of 2.9% p.a., and a loan value of $450,000. For every dollar in your high interest earning account, you earn 1.5% p.a., in this example that’s $300 p.a. or $25 p.m. to which can be used to contribute towards your loan repayments. If the same amount was in an offset account, the interest calculation will be based on a $430,000 loan, not $450,000, which means your monthly repayments would reduce from $1,088 to $1,040, a saving of $48 p.m., that’s an additional $23 saving over the money earned from your high interest account. This means your high interest account is only doing (roughly) half the job for you.

Interest is calculated on a daily basis, therefore (as mentioned) the more you have in the offset account, the less interest you end up paying on the mortgage, and with those savings you can look to contribute more to principal of the loan, therefore (potentially) shortening the life of the loan. One of the best ways to exploit the benefits of this feature is to have your salary or other sources of income paid directly into your offset account.

Why a redraw facility?

One of the main differences between an offset account and a redraw facility, an offset account is designed to reduce the value of the loan for which interest is calculated, but is not in fact a contribution to the loan, whilst a redraw facility allows you to make extra repayments towards the loan (on top of your regular repayment amounts) in an effort to reduce the loan term, and interest payable.

The benefit of a redraw facility is that, whilst your regular repayments might (usually) be split between a principal and interest portion, any extra repayments over and above this amount does not attract an interest component, meaning every dollar over your regular repayment contributes entirely towards reducing the principal portion of your loan. Much like an offset account, you can still have access to the extra repayments however this usually comes with a fee or a limit in the number of times you can withdraw funds before a fee is charged.

So, which is better?

The short answer, “it depends”.
If you are diligent with your money and have a strict savings and spending policy, then an offset might be the right solution for you, you might not be tempted to withdraw money out of the offset account to buy that new 75” TV or home theatre system, instead, you’re intention is to save the money for when you really need it.

The convenience and easy access to funds might not be the ideal solution for some, therefore, a redraw facility might be the ideal alternative. It still aims to achieve the same goal as an offset account (i.e. reduce the interest payable and reduce the life of the loan) however, it comes with a cost if you try to take money out too often, some lenders might limit the number of times you can withdraw, may impose a fee to do so and might set a minimum amount per withdrawal, all great deterrents for spend thrift borrowers looking to pay down their home loan quicker.

Another consideration might be the tax implications for those with investment property loans, using a redraw facility might help pay down the loan quicker but if you access those funds at any time during the life of the loan you may not be able to claim the extra repayments as a tax deduction, unless you can prove that the withdrawn funds are being used for further investment purposes. On the other hand, using an offset account and having funds sit there to reduce the interest payable might still avail you of a tax deduction against the full loan amount. We suggest talking to an accountant or financial adviser before making any decisions based on you tax position or outcome, we are not qualified to give this advice and the example used above is general in nature and does not take into account any personal circumstances.

If you’d like additional help making sense of which option is best for you, please contact us, we’d love to hear from you and help find you the right solution to care to your needs.