Offset vs Redraw - It isn't complicated
Key points to understand before deciding what is right for your situation
Understanding the Difference Between Offset Accounts and Redraw Facilities
When it comes to managing a mortgage, borrowers often look for ways to reduce interest payments and pay off their loan faster. Two common add on features that can help achieve these goals are offset accounts and redraw facilities. Although they serve similar purposes, they operate differently. Here's a closer look at each:
Offset Accounts
An offset account is a transaction account linked to your home loan. The balance in this account is offset against the amount you owe on your mortgage, reducing the interest charged.
How It Works:
If you have a mortgage of $600,000 and $20,000 in your offset account, interest will be calculated on $580,000.
The more money in your offset account, the less interest you pay on your loan.
You can deposit and withdraw funds from the offset account as needed, just like a regular transaction account.
Benefits:
Interest Savings: By reducing the principal on which interest is calculated, you can save a significant amount over the life of the loan.
Flexibility: Funds in the offset account are easily accessible for everyday transactions.
Tax Efficiency: Interest savings from an offset account are not considered taxable income. The purpose of the borrower funds will also be unchanged.
Considerations:
Some lenders may charge higher fees for loans with offset accounts.
Offset accounts are most beneficial for borrowers who can maintain a significant balance in the account.
Example:
Loan Amount: $300,000
Offset Account Balance: $20,000
Net Balance: $300,000 - $20,000 = $280,000
Interest is calculated on the $280,000 net balance instead of the full $300,000 loan amount. This effectively reduces the amount of interest you pay, allowing more of your repayment to go towards reducing the principal.
Interest Calculation:
Interest Rate: 6% per annum
Daily Interest Rate: 6% / 365 = 0.016438%
Daily interest with offset: $280,000 x 0.016438% = $46.03
Without Offset:
Daily interest without offset: $300,000 x 0.016438% = $49.32
So, for that day, you would be charged $46.03 in interest with the offset and $49.32 without the offset.
Redraw Facilities
A redraw facility allows you to make extra repayments on your mortgage and access those additional funds if needed.
How It Works:
If your minimum monthly repayment is $1,500 but you pay $2,000, the extra $500 can be redrawn if needed.
These extra repayments reduce the principal, thus reducing the interest charged over time.
Benefits:
Interest Savings: Extra repayments reduce the loan principal, leading to interest savings.
Access to Funds: You can withdraw the extra repayments if you need access to the funds.
Flexibility: It offers a way to manage unexpected expenses without needing separate savings.
Considerations:
Redraw facilities may have limits on how often and how much you can redraw.
Some lenders may charge fees for using the redraw facility.
It may not be as convenient as an offset account for regular transactions.
Example:
Loan Amount: $300,000
Extra Repayments Made: $20,000
Remaining Balance: $300,000 - $20,000 = $280,000
Interest is calculated on the $280,000 remaining balance. If you redraw some of the extra repayments, the balance on which interest is calculated will increase accordingly.
Interest Calculation:
Interest Rate: 6% per annum
Daily Interest Rate: 6% / 365 = 0.016438%
Daily interest with extra repayments: $280,000 x 0.016438% = $46.03
Without Extra Repayments:
Daily interest without extra repayments: $300,000 x 0.016438% = $49.32
For that day, you would be charged $46.03 in interest with the extra repayments and $49.32 without the extra repayments.
Repayments and Loan Balance
Offset Account:
Your repayments remain the same, but a larger portion goes towards the principal because the interest charged is lower due to the offset account balance.
If your monthly repayment is $1,500, and the interest portion for the month (calculated daily) is $1,400, then $100 goes towards reducing the principal.
Without the offset, if the interest portion is $1,479.60, then only $20.40 goes towards reducing the principal.
Redraw Facility:
Extra repayments reduce the principal directly, thus lowering the interest charged in subsequent periods.
If your monthly repayment is $1,500, and you make an extra repayment of $500, the principal is reduced faster. If the interest portion for the month is $1,450, then $1,550 ($1,500 regular repayment + $500 extra - $1,450 interest) goes towards reducing the principal.
Without the extra repayment, if the interest portion is $1,479.60, then $20.40 goes towards reducing the principal.
In both scenarios, the goal is to reduce the loan principal faster, thereby reducing the overall interest paid and shortening the loan term. The difference lies in how the interest is calculated and the flexibility in accessing the funds.
What information don’t you know?
Where is your money the safest?
Offset Account:
An offset account is a transactional account that is your asset, that you pay the bank to hold for you.
The Financial Claims Scheme (FCS) is an Australian Government scheme that provides protection to deposit-holders banking with authorised deposit-taking institutions or ADIs. The FCS is a government-backed safety net for deposits of up to $250,000 per account holder per ADI. So in your transactional offset account, $250,000 is covered by the scheme.
Amounts over $250,000 are subject to the same risks as any investment.
Redraw Facility:
A redraw balance is a portion of money paid in front of the scheduled loan repayments, it is paid into the loan, it is the banks asset, it is ‘their’ loan account, and if it has been paid in advance it is not guaranteed to be returned.
In the last decade or so, and always in hard times, there are numerous occasions that prominent ADI’s, without warning, have restricted or removed access to customers redraw. It is ‘their’ asset.
Some examples that I remember are:
Bank of Queensland (BOQ) (2021)
ANZ (Australia and New Zealand Banking Group) (2020)
NAB (National Australia Bank) (2020)
ME Bank (2020)
Westpac (2019)
Suncorp Bank (2015)
St. George Bank (2014)
ING Direct (2013)
Although you aren’t at risk of loosing the funds, like in an investment, you are at risk of losing access to them in hard times.
Which One is Right for You?
Choosing between an offset account and a redraw facility depends on your financial situation and goals, all you can do is educate yourself and decide which best suits you:
Offset Account: Are most ideal for those who can maintain a high balance and want easy access to their funds.
Redraw Facility: Suitable for borrowers who want to make extra repayments and have access to those funds for emergencies or large expenses.
Both options offer valuable benefits and can help reduce the total interest paid over the life of the loan. It's important to review the terms and conditions of your loan and consult with an expert to determine the best strategy for your needs.