When it comes to the offset vs redraw decision, it’s essential to know that each has distinct benefits.
Choosing the right offset account or redraw facility can save you money on interest and help you pay off your home loan sooner.
Let’s dive into how each works, their pros and cons, and how to decide which one suits your financial goals best.
What Is an Offset Account?
An offset account is a transaction account linked to your home loan. The balance in this account offsets the amount of your loan balance on which interest is calculated.
For example, if your home loan balance is $300,000 and you have $50,000 in your offset account, you will only pay interest on $250,000.
Key Benefits of an Offset Account:
- Easy Access: You can deposit and withdraw money at any time, just like a regular bank account.
- Interest Savings: The more money in your offset account, the less interest you pay on your home loan.
- Flexibility: Ideal for managing everyday expenses, as it acts like a normal transaction account.
What Is a Redraw Facility?
A redraw facility allows you to access extra repayments you’ve made on your home loan. These additional payments reduce your loan balance, which in turn reduces the interest charged.
However, unlike an offset account, the money isn’t readily accessible and might require a formal request to withdraw.
Key Benefits of a Redraw Facility:
- Interest Reduction: By making extra payments, you can significantly lower the interest charged over the life of the loan.
- Emergency Fund: Acts as a financial safety net, allowing you to access extra repayments when needed.
- Discipline: Since it’s harder to access, it encourages saving and reduces the temptation to spend(The Mortgage Agency, Cara Julian).
What are the Key Differences of Offset vs. Redraw?
While both options help reduce the amount of interest paid on a home loan, they have distinct features:
Accessibility:
An offset account offers easy access to funds through a debit card or online banking, making it ideal for regular use. In contrast, accessing funds in a redraw facility may take more time and may involve fees or minimum withdrawal amounts.
Tax Implications:
Money in an offset account doesn’t reduce your home loan balance for tax purposes, which can preserve interest deductibility, especially if you plan to convert your property into an investment property later on.
However, funds redrawn from a redraw facility may affect the tax deductibility if used for non-investment purposes (Investax).
Tax Implications of Offset Accounts and Redraw Facilities
Understanding the tax implications of using an offset account versus a redraw facility is crucial, especially if you plan to convert your primary residence into an investment property later.
“Funds in an offset account don’t reduce the home loan balance, which means you can preserve the original loan amount’s interest deductibility. “
Investax
This can be particularly beneficial if you decide to rent out the property in the future. The interest on the original loan amount remains tax deductible, offering potential long-term tax benefits.
“If you withdraw funds from a redraw facility and use them for non-investment purposes, the interest on that portion of the loan is no longer tax deductible. “
Investax
This can complicate tax calculations, especially if you plan to convert the property into an investment later. It’s essential to track how much is redrawn and its use to avoid losing valuable tax deductions.
How to Choose Between an Offset Account and a Redraw Facility?
Your choice between an offset account and a redraw facility should depend on your financial goals and personal circumstances.
Here’s a breakdown to help guide your decision:
- Best for Flexibility: If you need regular access to your funds and want the flexibility to manage your home loan with a linked transaction account, an offset account is the better choice.
- Best for Discipline: If you’re focused on paying off your home loan sooner and want a tool that encourages saving by limiting access to extra payments, a redraw facility might be more suitable.
- Best for Tax Planning: If you plan to turn your property into an investment property in the future, using an offset account may help preserve the tax deductibility of interest on your original loan balance.
Example Scenarios: Offset vs. Redraw
To illustrate the benefits of each option, let’s consider a couple of scenarios:
Scenario 1: The Frequent Spender
The Frequent Spender Sarah prefers to have easy access to her money for everyday expenses and emergencies.
She deposits her salary into her offset account each month, which helps reduce the interest on her home loan. This setup allows her to manage her finances flexibly while saving on interest.
Scenario 2: The Savvy Saver
The Savvy Saver John makes additional payments into his redraw facility whenever he has extra cash.
He doesn’t need immediate access to these funds, so he lets them accumulate, reducing his loan balance and the interest charged.
Over time, this approach helps John pay off his home loan faster while having the option to withdraw money in case of an emergency.
How to Maximise Savings with an Offset Account?
To make the most of your offset account, consider these strategies:
- Deposit All Income: Direct your salary and any other income into your offset account. The more money in the account, the more you save on interest.
- Keep Daily Expenses in the Offset Account: Use the account for daily transactions. Even short-term deposits can reduce your home loan interest.
- Avoid Large Withdrawals: The less you withdraw, the more you reduce your loan’s interest. Use other savings or emergency funds for large purchases.
- Automate Savings: Set up automatic transfers from your transaction account to your offset account to consistently build your balance.
What are the Best Practices for Using a Redraw Facility?
To effectively use a redraw facility, follow these tips:
- Make Regular Extra Repayments: Contribute extra funds whenever possible to reduce your loan balance and save on interest.
- Minimize Withdrawals: Only access the redraw funds in emergencies or for significant expenses, such as renovations, to maintain lower interest payments.
- Track Your Usage: Keep detailed records of your redraws to understand how they impact your loan and potential tax deductions.
- Consider Fees and Restrictions: Be aware of any fees or limits associated with accessing funds in your redraw facility. Planning for these can prevent unexpected costs.
Summary
Both an offset account and a redraw facility offer valuable ways to reduce interest on your home loan. The choice between them should be based on your need for accessibility, your financial discipline, and your long-term tax planning goals.
By understanding the differences and benefits of each, you can make an informed choice that aligns with your financial strategy.
For more insights on managing your home loan effectively, you might also want to explore the differences between a line of credit vs offset or check what is a good credit score when buying a home.
Questions and Answers about Offset vs. Redraw
What is better, redraw or offset?
A redraw facility and an offset account have their own advantages. The best choice depends on your financial situation and the type of loan you have. Offset accounts are not available on all loans, whereas redraw facilities are (provided you activate them).
Can you have redraw and offset at the same time?
Yes, you can use both a redraw facility and an offset account simultaneously. For example, you could make extra repayments into your home loan using the redraw facility and deposit your salary into the offset account.
Is it better to pay off a mortgage or keep money in an offset account?
Typically, homeowners may benefit more from keeping spare cash in an offset account since home loan interest rates are usually higher than those offered by savings accounts.
What are the pros and cons of an offset account?
Pro: Saves on interest repayments, as a higher balance in your offset account can significantly reduce interest costs.
Con: Home loans with an offset account generally have relatively higher interest rates.
Can banks refuse redraw?
Yes, lenders may refuse a redraw request at their discretion, so it’s essential to read the fine print before relying on a redraw facility.
Can I use my redraw to pay my mortgage?
Yes, you can use the funds in your redraw facility to make mortgage repayments, potentially helping you pay off your loan sooner.
Do you pay tax on redraw?
The Australian Taxation Office (ATO) treats redraws as new borrowing. The tax deductibility of the interest depends on whether the redrawn funds are used for income-producing or private purposes.
What happens to my redraw when I sell my house?
By the end of your loan term, both your available redraw balance and home loan balance should be zero, as the funds in the redraw facility reduce over the course of the loan.
Why has my redraw gone down?
Your available redraw may appear lower due to the daily interest calculation and the end-of-month interest charge, which may reduce the balance until your next repayment.
Can I offset 100% of my mortgage?
Yes, a 100% offset account allows you to use every dollar in the account to offset the interest on your home loan. This feature is more common with variable rate home loans.
What are the disadvantages of an offset mortgage?
Drawbacks:
- You usually need a high deposit, often at least 25%, in addition to the offset savings.
- Offset mortgages often have higher interest rates compared to standard mortgages.
- The choice of lenders offering this feature may be limited.
