The Lowdown on Redraw and Offset Accounts

Let’s face it, everyone wants to save on their home loan. One of the best ways you can do this is by using an offset account. But what is an offset account exactly, and how does it work? In this post, we’ll look at these questions in more detail, as well as discuss redraw facilities.

What Is an Offset Account and what can it do for me?

With this account, any money in it will be deducted from your home loan’s balance when your lender calculates your interest.

As a result, you’ll save on interest, and you’re able to pay your home loan off sooner. As a bonus, the money in your offset account is also easily accessible, and you can deposit and withdraw funds as you like. Now, this sounds like a win-win situation.

An offset account is a transaction savings account that’s linked to your home loan. You can use this account the same as you would a regular transaction account. This means you’ll be able to make deposits or withdrawals from the account as you usually would, and often has a linked debit card.

The big difference is that with an offset account, the amount available is set off (offset, get it?) against the amount you owe on your home loan.

As a result, when you keep money in your offset account over a period of time, you’re able to reduce the amount of interest you will pay on your home loan.

In simple terms, the higher the account balance in your offset account and the longer the period you keep the money there, the less interest your pay on your home loan. This could, ultimately, help you pay off your home loan sooner.

Generally, offset accounts have a yearly or monthly fee, so you’ll have to account for this when calculating your savings for utilising this type of account.

Different Types of Offset Accounts

There are two main types of offset accounts:

• 100% offset. This is the type of offset account that most lenders offer. Like our example above, the total amount available in your offset account is deducted from the balance of your home loan when the interest is calculated. The effect of this is you get the same interest reduction as you would when you paid that amount directly into your home loan.

• Partial offset. Some lenders may offer you a partial offset account only. This is generally the case with fixed-rate home loans. With this offset account, only a percentage of the amount available in the account is deducted from the balance of your home loan when the interest is calculated. So, for example, if you have a 50% offset account and you have $50,000 in the account, only $25,000 would be used to reduce your interest.

How Much Can You Save With an Offset Account?

To show you how much you can save with an offset account, let’s look at some examples. For all the examples, we’ll use a home loan of $500,000 for 30 years with an interest rate of 4%. We’ll also use a 100% offset account.

Example 1

For our first example, we’ll use an offset account with a balance of $10,000 from the loan’s inception. In this example, you’ll save $22,444.25 on interest, and you’ll reduce the loan period by nine months. After the first 10 years, your total amount owing on the loan will be reduced by over $4000, and after 20 years, the amount will be reduced by over $12,000.

Example 2

In our second example, we’ll use an offset account with a balance of $20,000 from the loan’s inception. Here, you’ll save $43,485.21 on interest, and you’ll reduce the loan period by one year and six months. After the first 10 years, the total amount owing on your loan will be reduced by over $7000, and after 20 years, the balance outstanding on the loan will be reduced by over $24,000.

Example 3

In our next example, we’ll increase the balance of the offset account to $40,000 from the inception of the loan. In this scenario, you’ll save $81,807.40 on interest while you’ll be reducing the loan by two years and ten months. Here, after 10 years, the amount outstanding on the loan will be reduced by almost $20,000, and at 20 years, this increases to nearly $50,000.

Example 4

In our final example, we’ll use an offset account with a balance of $80,000 from the loan’s inception. Here, you’ll save $145,901.41 on interest, and you reduce the loan period by five years. By year 10, you would’ve decreased the amount owing on the loan by almost $40,000, and after year 20 this amount would decrease by nearly $100,000.

An offset account works with your savings account

How is my account linked?

An offset account allows you to set off its balance against the amount you owe on your home loan. In other words, depending on the type of offset account you choose, the money available in the account is deducted from the balance of your home loan before the interest is calculated.

The best way to explain it is by using an example.

Let’s say that you have a $500,000 home loan, and you have an offset account. Now let’s say you deposit $100,000 into your offset account.

When the interest is calculated, the $100,000 in your offset account will be deducted from the balance of your home loan. Because of this, the interest will only be calculated on $400,000, and this will be the case for as long as you keep the $100,000 in your offset account.

How does it benefit me? Are there any restrictions?

Now that you know how an offset account works, let’s look at some of the benefits if you use one as a borrower. Obviously, the main advantage of having an offset account is that you pay less interest on your home loan. And by saving interest, you can reduce the repayment period of your home loan significantly.

The best of all is that it’s unnecessary to put massive amounts of money into your offset account because, for example, with a 100% offset account, the entire amount will be taken into account when calculating your home loan interest.

In addition to this, there are several other benefits you’ll enjoy by using an offset account:

• Generally, you can deposit and withdraw funds from the account as often as you like. There are also no limits on the amount you can withdraw. As a result, an offset account is an easy way to save on the interest of your home loan while still having money available if your financial situation changes or if something unexpected happens.
• With an offset account, you’ll be able to gain the most benefits from your extra income. Because you typically pay more interest on your home loan than you’ll earn in a savings account, you gain more by using this offset account compared to just saving.
• When you use an offset account, you also have some tax benefits. This is because, according to the Australian Taxation Office (ATO), you won’t pay tax on the interest you save by using an offset account. In contrast, you’ll have to pay tax on the interest you earn in a savings account.

Drawbacks of an Offset Account

Unfortunately, like with many things in life, offset accounts have some drawbacks that you need to keep in mind when considering whether you should use an offset account.

These drawbacks are:

• Offset accounts are typically more expensive than other types of loans. As such, the interest rate is usually higher, and there are also additional bank charges that you’ll need to pay. Because of this, it has the potential for higher fees.
• Although you have the freedom to deposit and withdraw as you like and, depending on the account, the entire amount available will be set off against your home loan, you need a fairly large deposit to enjoy the full benefits of an offset account. In simple terms, if you only have a small amount in your offset account, it may not be enough to cover the bank charges while still reducing your interest rate. So, if you only have a small amount to deposit, you may be better off with a standard variable rate home loan.

Is an Offset Account Right for You?

To decide whether an offset account is the right option for you, there are several things you should consider. If you want easy access to your extra savings while also reducing the interest you’ll pay on your home loan, an offset account might be a good option for you.

Keep in mind, though, that most lenders will charge you a fee for an offset account, whether it’s a monthly fee or an annual fee. So, you’ll have to consider whether the amount of interest you’ll save on your loan will be more than these fees. If it isn’t, it doesn’t make much sense to opt for an offset account.

This, in turn, depends on how much money you’re going to deposit into the offset account. If you don’t have a large amount available, it may not be worth your while as the fees will be too high.

Ultimately, every situation and every person’s financial needs differ, so, taking into account all these factors, you should decide whether an offset account is the right solution for you.

How to Use an Offset Account

If it is the right solution, you’re probably wondering how you can use an offset account to reduce the interest on your home loan.

There are several ways you could do this:

• Use it for savings. One of the easiest ways for you to use an offset account is to use it for your savings. So, if you have any extra money, you’re able to deposit it into your offset account and leave it there to maximise your savings on interest.
• Replace your bank account. Because it’s a transaction account, you’ll be able to replace your regular bank account with your offset account. In this way, there’s always money in the account that can be taken into account when interest is calculated on your home loan.
• Deposit your salary into the account. When you replace your bank account with an offset account, it’s a good idea to have your salary deposited into the account. When you do this, your salary will be set off against your loan, and you’ll save on interest.
• Combine it with your credit card. You can combine an offset account with your credit card by keeping money in your offset account and using your credit card for your daily expenses. As a result, you’ll save more on the interest on your home loan. Just remember to pay back your credit card balance at the end of the month to avoid interest and late payment fees, which would eliminate the savings you’ll gain.

What is a redraw facility?

If you’ve made considerable extra repayments or lump-sum payments on your home loan, you may be able to redraw some of this money. This could be used as extra funds for something such as an upcoming renovation you‘re planning. This is essentially an alternative to taking out a personal loan when/if a need for extra funds arises. Your redraw facility is an account that contains any additional repayments (whether it be lump-sum or extra repayments). The funds within this account reduce the balance of your home loan and with this decrease the amount of interest you’ll pay over the loan term.

An extra repayment is when you increase your regular monthly repayments, for example, you choose to pay $700 regularly, in an effort to pay off your loan faster, and the regular payment is set to be $600. A lump-sum payment refers to a one-off payment to the home loan.

How much can I get back in a redraw?

Each lender has its own minimum and maximum redraw amount so it’s best to contact the lender or visit their website for more information. It should be noted that there is also typically a redraw fee charged.

You’ll be able to access your funds from your redraw through EFTPOS, the branch, online banking, or ATM withdrawals.

What are the pros and cons of a redraw home loan?

Pros

• As the amount you are able to redraw on your loan is based on the extra repayments you have made, there is the potential that you can borrow more than you would be able to with a personal loan, provided your lender has no maximum redraw limit
• Redraw home loans are easy to manage as you will only have the one home loan repayment

Cons

• You may pay significantly more in interest in the long-term as home loans typically have a far greater lifespan than a personal loan would.
• You’re potentially undoing the hard work that you have put into making additional repayments and lump-sum payments to pay off your loan quicker and reduce the interest that you would pay long-term. This is dependent on your personal objectives

Are there any alternatives to a redraw?

Line of credit loan

A line of credit loan is another option that involves refinancing your home loan to a line of credit loan, which is based on the equity that you hold in your property. This will decrease the amount of equity that you hold in your property, but it provides a revolving loan facility that you can draw on whenever you want at a capped amount.

Home loan top-up

By holding equity in your property, there is the alternative option of increasing the limit of your current home loan. However, you should be mindful that by using a home loan top-up, the interest you pay in the long run with be significantly increased as it would when you redraw.

What is the difference between Offset and Redraw home loans?

Now, you may wonder why you shouldn’t use a redraw facility instead of an offset account. This is a perfectly valid question because both of these are common home loan features, and they work in a similar way.

There are, however, some significant differences between the two. These differences include:

• Generally, there are lower monthly fees on redraw products. Offset accounts may have higher account-keeping fees and some transaction fees, while redraw facilities are usually available on low or no-fee basic variable home loan products. This is because the bank or lender does not need to maintain two accounts for you.
• Both have good withdrawal availability. As an offset account is a separate transaction account, you’ll have no limits on what you can deposit and withdraw from the account. Because of this, the money in your offset account is always available for you to withdraw, and you can use it for things like groceries, shopping, or paying bills. In contrast, a redraw facility is not a separate account, but it’s 'inside' your loan account itself.
• Redraws with linked Debit Cards. Some basic variable interest rate loan accounts with redraw do have a linked debit card, which makes day-to-day transacting much easier and more like using a normal savings account. In any case, if you had a basic variable home loan you can transfer funds from one account to another at the same bank instantly, to access the funds on a credit card, debit card, or make a BPAY, Osko, internet banking transfer or EFTPOS transaction. Easy!
• Redraw facilities generally are only accessible on variable-rate home loans, however, a lot of Australian homeowners use both redraw facilities and offset accounts.
• Savings are more automated with offset. With an offset account, there are fewer transfers you will need to make as each dollar that is in the linked savings account is offsetting the loan. So, if you are a "set it and forget it" type of person an offset arrangement is less hassle. In contrast, a redraw facility does mean you will need to manually sweep cash into the redraw from time to time. For some people, this is totally fine as most of us log into internet banking each day anyway. So, next time you are logged in, do a sweep into the redraw or set up an automatic payment to sweep at each payday.
• Redraws can help you limit unnecessary spending. This is because it’s more manual to access the money in a redraw facility, it could help curb unnecessary spending. In contrast, because accessing money in an offset account is easier, it’s also easier to spend.
• For investors, an offset is usually better for tax purposes. For your own home, either is OK. There may be tax implications when using a redraw facility and offset accounts for investment properties. So, if you decide to rent out your home as an investment property, the interest you pay on your loan may be tax-deductible. However, you may not be able to claim interest on the portion of the loan you’ve withdrawn from the redraw facility. In contrast, an offset account will not affect the tax deductibility of the interest you pay on your loan.

Can I utilise either of these if I have a fixed-rate loan?

Redraw facilities and offset accounts aren’t a sure thing for borrowers with a fixed-rate home loan. If you want or already have a home loan with a fixed interest rate, it may require an extended search to find a loan that suits your needs. Investors can use offset accounts too.

If you repay your fixed loan early or violate the loan terms, most lenders will charge you break fees. By using offset accounts and redraw facilities, you may be able to pay off your mortgage more easily and sooner, however it is important to consider any consequences such as this when utilising them.

By having a variable rate home loan, you get additional flexibility, paired with fewer restrictions when using either offset account or redraw facilties. If you already have a fixed rate home loan, to avoid the potential of break costs, you should wait until your fixed term ends and then make the switch to a variable interest rate.

The Bottom Line

An offset account is an easy way for you to make interest savings on your home loan. And when you save on interest, you’ll be able to pay your home loan off sooner. While you do this, you also don’t have to worry about your money not being accessible because you can use an offset account as your daily transaction account to withdraw and deposit as you like.

So, if this sounds good to you, it may be worth your while to consider an offset account. Keep in mind, though, that it’s not the perfect solution for everyone, and you should carefully consider your needs and requirements before opening an offset account. Redraw facilities can also help you save money over your loan term.

If you want to know more about offset accounts, redraw facilities or home loans, visit our website or contact us for more information.