Before going ahead and applying for a home loan, you should consider your current financial capabilities and your goals so that you can choose the structure best suited to you – that includes considering additional facilities such as an offset account or a redraw facility.
These features could be the difference in thousands of dollars of savings, so it’s worth understanding how they work.
To help you make an informed decision about choosing one of these features (or not choosing them at all), we’ve broken down everything you need to know – including the difference between offset accounts and redraw facilities and each of their pros and cons.
What Is an Offset Account?
An offset account is a transaction account linked to your home loan, which allows you to freely deposit and withdraw money regularly – as you would with your standard bank account.
How Do Offset Accounts Work?
Offset accounts allow you to hold some of your home loan balance in a transaction account. The money in this account is ‘offset’ against your home loan debt when interest is calculated.
For example, suppose your mortgage balance is $500,000, and you transfer $20,000 of that balance into your offset account. If that’s the case, you’ll only have to pay interest on the remaining balance, which is $480,000.
Inevitably, the more money you have in your offset account, the smaller the amount that you are being charged interest on.
Using Your Offset Account as a Transaction Account
You can use offset accounts as a regular transactional account and withdraw cash or swipe for purchases.
If you deposit money into your offset account, the funds are immediately available – you don’t need to withdraw money from another account to use.
You can arrange for your salary to be directly deposited into your offset account. Then, until you start spending that money, the balance will be offset against your home loan.
It’s worth keeping in mind that the more you spend from the offset account, the lower its balance will be. For this reason, many people choose to use an offset account as a savings account.
Could Your Savings Earn More Interest Compared to a Savings Account?
A significant benefit of an offset account is that it often attracts high-interest rates compared to a traditional savings account.
So, not only would you be saving on your mortgage repayments, but you could end up earning more interest on your savings in a way of reducing interest charged on your loan.
What’s more, according to the Australian Tax Office (ATO), interest earned on your offset account savings won’t be taxable income. On the other hand, interest earned in a traditional savings account is taxable income.
Margi has a home loan balance of $285,000, on which she pays a 7% fixed interest rate each year.
If she kept $25,000 in her offset account, she could be saving $1,750 each year.
However, Margi is keeping that money in a savings account which is only earning her 5% interest each year, and she’s taxed at a rate of 15% each year.
So, instead of saving $1,750, Margi is only saving $1,062.50:
$25,000 x 5% = $1,250
$1,250 – 15% income tax = $1,062.50
Using Your Mortgage Offset Account To Pay Off Your Loan Account Faster?
Offset accounts don’t affect the amount you pay in monthly mortgage repayments.
The amount you’re required to pay is what you will continue paying until your home loan has reached completion.
The reason why you could pay off your home loan sooner than expected is that the more money in your linked offset account, the less interest you will be paying over the years.
What Is a Redraw Facility?
- making additional repayments, or
- depositing a lump sum.
How Do Redraw Accounts Work?
While a redraw facility differs from an offset account, it’s also a mechanism to save on your home loan.
Suppose you’ve made it a habit to pay an extra $500 with your minimum repayment each month. If that is the case, you can choose to redraw those extra repayments in a time of need, or you can use it to pay off your home loan quicker.
For example, if you’ve paid an extra $55,000 towards your home loan and you don’t withdraw it, that $55,000 will be used to pay off your mortgage balance faster.
Can I Use the Redraw Facility as a Savings Account?
Money in your redraw facility doesn’t receive any interest.
Instead, money in your redraw facility reduces the amount of time you pay off your home loan, which subsequently reduces the amount of interest you have to pay.
Interest rates on home loans are generally higher than a savings account. By opting to save your money in the redraw facility instead, the money saved from your home loan’s interest will effectively be more than the money you would have gained in interest from a savings account.
You also have the added benefit of not having to pay income tax if you keep your money in a redraw facility instead of a savings account.
Using Your Redraw Facility To Pay off Your Home Loan Faster
The more money you keep in your redraw facility, the less you owe towards your home loan. If you maintain this balance, you’ll pay off your loan account faster.
If you elect to redraw your facility’s money, you’ll just continue paying your home loan over the original time period.
This isn’t always a feature in a home loan, though, so be sure to discuss with your mortgage broker beforehand if this is a strategy you are interested in using.
Similarities Between Offset Account vs Redraw Facilities
These two home loan features are pretty similar in that:
- It’s more beneficial to use either of these features as a savings account than opening a standard saving account. This is because the interest saved from your home loan is higher than the interest gained from a traditional savings account.
- Earnings in either of these accounts aren’t taxable.
- They can reduce the length of your loan.
Offset vs Redraw Differences
|Offset Accounts||Redraw Facilities|
|The money in the offset account is offset against your home loan, allowing for a reduced interest.||Extra repayments are transferred into a redraw facility used towards your principal.|
|It can be used as a fee-free regular transaction account, and you can withdraw and swipe immediately, as much as you like.||You can only access this money once transferred out.|
|Monthly repayments remain the same.||Monthly repayments can be reduced.|
Both home loan features offer an excellent savings account option where you will save on a substantial amount of interest and result in your loan amount being paid off quicker.
Although both are most advantageous when leaving as much funds in the account as possible, an offset account will be best suited if you want easy access to that money.
It is important to remember that these features need to be set up before taking out your home loan. For this reason, it is worth seeking advice from a mortgage broker so they can assist you in your decision and weigh up which option better suits you and your individual situation.
These features are but a small piece of your home loan puzzle, and your mortgage broker can play a big part in helping you optimise your home loan every step of the way.
At The Mortgage Agency, we focus on getting the right outcome based on your specific financial circumstances. So, if you need help deciding on different home loan products and their features, get in touch with one of our expert mortgage brokers today.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.