What's the difference between Offset Accounts and Redraw Facilities, and which is better?

When exploring home loan options in Australia, borrowers often encounter terms like "offset accounts" and "redraw facilities." These features can help borrowers save on interest and manage their mortgages more effectively, but they operate differently and offer distinct benefits. In this article, we'll delve deeper into what offset accounts and redraw facilities are, how they work, and the advantages they provide to borrowers.

Offset Accounts

An offset account is a type of transaction account linked to your home loan. Instead of earning interest on the balance of this account, the funds are used to reduce the interest payable on your mortgage. For example, if you have a $300,000 home loan and an offset account balance of $50,000, you'll only pay interest on $250,000 of your mortgage.

How It Works

The balance in the offset account directly reduces the loan balance used to calculate the interest, effectively lowering the interest charged on the home loan. The more money you have in your offset account, the less interest you pay. This means you can reduce your overall mortgage term without needing to make additional repayments, as the interest saved goes directly toward reducing the principal.

Benefits of Offset Accounts

1. Interest Savings: The key benefit of an offset account is the reduction in interest costs. Over the life of a 25- or 30-year loan, this can add up to significant savings, helping you pay off your loan faster.
2. Flexibility: Unlike traditional mortgage repayment accounts, an offset account lets you withdraw and deposit money freely, much like a regular transaction account. This flexibility is particularly useful for those with fluctuating income or needing access to funds for other financial obligations.
3. Tax Efficiency: For investors, offset accounts provide a tax-efficient way to reduce the mortgage balance without earning taxable income. The interest savings are effectively "tax-free," making it an attractive option for people with investment properties.

Drawbacks of Offset Accounts

1. No Reduction in Loan Repayments: Using an offset account doesn't lower your loan repayments; it only reduces the interest charged. Borrowers will still need to meet their regular repayment amounts, which could be a downside if cash flow is tight.
2. No Interest Earned: Unlike savings accounts, the money in an offset account does not earn interest. While it reduces the loan interest, there’s no direct income generated from the balance in the account.
3. Limited Availability for Fixed-Rate Loans: Offset accounts are typically only available with variable-rate home loans, which might not suit borrowers who prefer the stability of a fixed-rate loan.

Common Uses of Offset Accounts

Offset accounts are typically suited for individuals who want to actively manage their finances, often utilising their salary and savings to reduce interest without locking away funds. These accounts are particularly useful for families or professionals with large cash flows, allowing them to benefit from short-term cash holdings.

Tax Implications of an Offset Account

Offset accounts have a different tax treatment. The presence of an offset account and the withdrawal of funds do not alter the nature of the original loan, meaning no new loan is created for tax purposes. The interest deductibility continues to depend on the original purpose of the loan. If the loan was used to purchase an income-producing property, the interest remains tax-deductible.

It's always recommended to consult a tax professional for personalised advice regarding the tax implications of using an offset account or redraw facility.

Source: ZedPlus, 2024

Redraw Facilities

A redraw facility allows borrowers to access any extra repayments they've made on their home loan. When you make voluntary or additional repayments beyond the required monthly payment, these funds are stored in your loan account. The redraw facility lets you withdraw these funds later if needed.

How It Works

Borrowers who pay more than their scheduled monthly repayments can access these surplus funds by "redrawing" them. The amount available for redraw is essentially the extra payments made above the minimum required. While these extra repayments reduce your outstanding balance (and thus your interest payable), the redraw facility gives you the ability to access them should the need arise.

Benefits of Redraw Facilities

1. Access to Extra Repayments: Redraw facilities allow you to use the extra repayments for unexpected expenses, renovations, or even investments, offering a practical financial safety net.
2. Simplicity: Redraw facilities are linked directly to the home loan account, so there’s no need for a separate account or extra management. This makes it easier to track your loan balance and extra repayments in one place.
3. Long-term Interest Savings: While funds in a redraw facility don’t reduce the interest on a daily basis like an offset account, making extra repayments lowers the outstanding balance, which ultimately reduces the interest accrued over time.

Drawback of Redraw Facilities

1. Redraw Fees: Some lenders may charge fees each time you make a redraw, which can add up if you frequently access extra repayments.
2. Redraw Limits: There may be restrictions, such as minimum or maximum redraw amounts, or a cap on the number of redraws allowed within a certain time period, limiting flexibility.
3. Changing Terms: Lenders often include clauses that allow them to change the terms of the redraw facility or even cancel it, though they are required to notify you. This uncertainty can affect long-term planning.

Common Uses of Redraw Facilities

Redraw facilities work best for borrowers who want the option to access extra repayments while ensuring they’re lowering their overall loan balance. People who might need funds for unexpected circumstances (e.g., home renovations or medical expenses) find this feature particularly useful.

Tax Implications of Redrew Facility

When using a redraw facility, each redraw is treated as a new loan for tax purposes. The tax deductibility of the interest on the redrawn amount depends on the purpose of the funds.

For instance, if the funds are redrawn for personal expenses—such as purchasing a car or renovating your home—the interest on that amount will not be tax-deductible, as these expenses are not related to generating income. However, if you have converted your home into an investment property and use the redraw to fund another income-producing asset, the interest on the redrawn amount may become tax-deductible.

Source: ZedPlus, 2024

Key Differences and Considerations

Interest Calculation

An offset account directly reduces the amount of interest charged by using the account balance to offset the mortgage principal. In contrast, a redraw facility reduces interest by lowering the principal through extra repayments, but the money is not actively offset daily.

Flexibility vs. Accessibility

Offset accounts provide flexibility in managing your finances day-to-day, allowing easy access to your savings without the need to make withdrawals or adjustments to your mortgage. Redraw facilities, on the other hand, offer borrowers the ability to access extra repayments they’ve already made, but some lenders may place limits on the amount that can be redrawn or impose fees for doing so.

Fees and Conditions

Both features can come with additional fees. Some lenders charge ongoing fees for maintaining offset accounts, while others may impose redraw fees or limit how often you can access funds. It's essential to compare these costs and any restrictions when choosing between the two options. Furthermore, some basic home loans might not offer these features at all, so it's worth considering this when selecting a loan product.

Which Option Is Best for You?

Choosing between an offset account and a redraw facility comes down to your financial situation and long-term goals.

• Offset accounts are better for borrowers with large savings or those who want to manage short-term cash flow while minimising interest on their mortgage. It’s a great option if you have substantial funds that you don’t want tied up, giving you flexibility with easy access to money.
• Redraw facilities are ideal for those focused on paying off their mortgage faster but who might want to access extra funds in the future. This can be a useful tool for people who want to make additional repayments when possible, while still keeping an emergency buffer of funds that can be accessed if needed.
  

Key takeaways

• Offset accounts and redraw facilities offer effective ways to save on interest and accelerate the repayment of home loans.
• An offset account reduces the interest charged by offsetting the savings in the account against the outstanding loan balance.
• A redraw facility allows borrowers to access the extra repayments they’ve made on their home loan.
• The tax implications differ between offset accounts and redraw facilities, depending on how funds are used and the original purpose of the loan.
• For personalised advice, consult a financial advisor or mortgage broker to determine which option best suits your financial goals.