When thinking about home loan options there are lots of different features to consider, and often it’s in language not commonly understood by a new borrower. The terms offset and redraw are often part of that lingo. Understanding the difference between the two and choosing the best option for your current situation and future plans can make a big difference.
What is Redraw?
Redraw can be accessed in many variable rate loans. When you have a loan but pay more than the minimum amount required monthly you build up what is commonly referred to as an “ahead amount.” Over time you can build this amount up and treat it as savings. The funds you have available in your ahead amount can then be accessed and pulled back out of your loan for you to spend. The benefit to leaving the funds available in redraw as opposed to your everyday bank account is that you’ve paid off your loan early and save on interest costs until you need your funds again.
What is Offset?
An offset account works similarly to redraw, except that instead of paying additional funds into the loan itself, you get a transactional bank account that sits alongside the loan. All of the savings that you put into the account offset the interest that you are paying. This can be your everyday transaction account so that your wage goes directly into this account, saving you interest for each dollar in the account for as long as it is there.
What makes one better than the other and vice versa?
Let’s use an example to illustrate the difference. Say you have a home loan of $500,000. For the ease of numbers we’ll say that the loan is interest only and that the monthly interest payment is $1,000. If you have $20,000 of savings to pay directly into the loan, your new loan balance would be $480,000 and you would have available redraw of $20,000. Your regular interest repayments might drop to $950 per month because you’ve paid down your loan. When you wish to access that $20,000 again you redraw the funds, spend it on what you like, and your loan balance goes back up to $500,000 with repayments of $1,000.
Now let’s say that you have the same $500,000 loan but you have a 100% offset account attached to it. You take your $20,000 and put it in the offset account. Your loan balance remains $500,000 but your interest repayments still drop from $1,000 to $950 because interest is calculated on difference between the loan balance and the offset balance.
So far, they look pretty similar in terms of benefit, but there are a few of major differences with using an offset account.
It is an everyday transactional account, so you can have your pay direct deposited into it, have a debit card attached to it, and make regular transfers in and out whenever you like. It is just like any other bank account and the money is yours and protected. Some redraw facilities have a limit to how much you can take out at one time as well as how often you can access your redraw.
Some lenders offer multiple offsets on one loan so you can manage your funds the way you want and still get maximum interest saving benefits. If you prefer to have one account that you keep your savings in, one that is for day-to-day spending, and one that covers the bills you pay maybe monthly, quarterly, or annually, having multiple offset accounts allows you to clearly budget and see how well you’re doing on your savings goals.
Fixed rate loans can provide great rates with certainty around your repayments. While most fixed rate products do not give you much flexibility to make additional repayments or pay your loans down early, there are instances with some lenders where fixed rate loans can have offset accounts attached. This can effectively give you the flexibility of a variable rate with the certainty of a fixed rate, and who doesn’t love getting the best of both worlds?
Redraw versus offset on your loan can have tax implications in the future. The future use of your property and savings are important to consider at the outset of your loan so that you put yourself in the best possible position down the track. Trust me, future you will be so happy with your foresight you’ve shown!
Because offset accounts have so many additional benefits, they often come with additional costs. Some banks require you to have a package with an annual fee to gain the benefit of an offset account. Others have higher interest rates associated with offset loans versus basic loans. Whether or not the benefit of having an offset account outweighs the slightly higher cost depends on your individual circumstances and your short and long term goals.
It is really important to talk your home loan consultant about the difference between the facilities and which one is right for you to minimise costs and maximise benefits for your specific circumstances.
The Credabl team is available to chat live on our website www.credabl.com.au or you can call one of our specialist lenders on 1300 27 33 22.
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