Two popular features that borrowers often inquire about are “Offset Accounts” and “Redraw Facilities.” These features can help borrowers save on interest and manage their home loans more effectively. In this article, we’ll delve into what offset accounts and redraw facilities are, highlight their differences, and explore the advantages they offer to borrowers in Australia.
What is an Offset Account?
An offset account is a transactional bank account linked to a home loan. It allows borrowers to reduce the amount of interest paid on their mortgage by using the balance in the offset account to offset the principal amount owed on the loan. The more funds deposited into the offset account, the less interest the borrower will pay on their home loan, potentially saving them thousands of dollars over the life of the loan.
What is a Redraw Facility?
A redraw facility, on the other hand, is a feature offered by some home loans that enables borrowers to access any additional repayments they have made above their minimum required repayments. These surplus funds are usually accessible through internet banking or over-the-counter withdrawals. The redraw facility allows borrowers to make extra payments into their mortgage and have the flexibility to redraw those funds when needed, such as for emergencies or major expenses.
Differences between Offset Accounts and Redraw Facilities
Purpose: An offset account is primarily focused on reducing the interest payable on the loan, whereas a redraw facility emphasizes flexibility in accessing extra repayments, although extra repayments will also reduce the interest payable.
Interest Calculation: With an offset account, the interest is calculated based on the outstanding loan amount minus the balance in the offset account. In contrast, a redraw facility doesn’t impact the interest calculation directly, as the surplus funds are applied towards reducing the principal balance. The interest is calculated daily based on the principal balance and charged monthly.
Accessibility: An offset account operates like a regular transactional account, allowing easy access to funds for day-to-day expenses. In contrast, accessing funds from a redraw facility might involve a few extra steps, such as transferring the extra redraw amount out of the loan into a bank account or submitting a manual request to the lender.
Tax Considerations: The funds held in an offset account do not earn interest, but the borrower benefits from reduced interest expenses, which can have potential tax advantages. An offset account against an investment loan helps to save interest but also maintain the tax deductibility of the interest on the loan. i.e. if funds are withdrawn from the offset account against an investment loan and used for personal purposes you may still be able to claim the increased interest expense as a tax deduction after the withdrawal. This may not be the case with a redraw facility. Seek the advice of your accountant.
Advantages of an Offset Account
a. Reduced Interest: By keeping surplus funds in an offset account, borrowers can decrease the amount of interest they owe, potentially helping them pay off their mortgage faster.
b. Flexibility: An offset account provides the convenience of easy access to funds for daily expenses without the need to formally apply for a withdrawal.
c. Potential Tax Benefits: As the funds in an offset account effectively reduce the outstanding loan balance, borrowers may have tax advantages, particularly for investment properties.
d. Safety: The funds in an offset account remain separate from the home loan, providing a level of financial security in case of unexpected events. If the offset account is held with a licensed bank the Commonwealth government guarantees up to $250k in the unlikely event the bank were to fail.
Advantages of a Redraw Facility
a. Additional Repayment Flexibility: A redraw facility allows borrowers to make extra repayments when they have surplus funds, helping them save on interest while maintaining accessibility to those funds when necessary.
b. Emergency Funds: The ability to redraw extra repayments can act as a safety net during emergencies or unforeseen expenses.
c. Debt Consolidation: For borrowers who have made extra repayments, a redraw facility can be used to consolidate other debts, potentially simplifying their financial situation.
d. Interest Savings: Like an offset account, using a redraw facility to make additional repayments can lead to substantial interest savings over the life of the loan.
Both offset accounts and redraw facilities offer significant advantages to borrowers in Australia. The decision on which option is best suited for a borrower depends on their individual financial goals and circumstances.