Most of us have probably heard of the terms ‘offset account’ and ‘redraw facility’, but what actually are they, and how can you use them to leverage your wealth? This article explains what offset accounts and redraw facilities are, how they can benefit property owners, as well as considerations to make before taking them out.
What is an offset account?
You can think of an offset account like a high interest savings account, except rather than earning interest, you reduce the interest payable on your home loan. For example, if you had a home loan which was $750,000, and you didn’t have an offset account set up, you are paying interest on $750,000. Now if you had an offset account attached to your loan, and you had $100,000 sitting in the offset account, you only pay interest on $650,000.
Now you might think, well why is that better than a traditional savings account? Well, the interest rate on your home loan might be around 3.5%, which means that for every $100 of loan that you have, you need to cough up $3.50 (p.a.). So offsetting your loan by $100 will result in a savings of $3.50 each year.
Compare this to your savings account which might be around 1.8%, which means that for every $100 you have in savings you are receiving $1.80 (p.a.), and this is before the tax man takes his slice. So depending on your taxable income, the net profit might only be around $1.20!
So you can either not have an offset account, and receive $1.20 (p.a.) from interest in your savings account, but still have to cough up $3.50 on your home loan. Or you can have an offset account, and receive no interest from a savings account, but not have to cough up $3.50 because your loan is offset. At the end of the year you will have an additional $2.30 ($3.50 – $1.20) in the bank, because you didn’t have to pay interest on your home loan!
Additionally, an offset account works similarly to an everyday transaction account. So if you need the money for an emergency, you can access it quickly and easily. If you didn’t have an offset account set up, you may not be able to access funds unless you have a redraw facility.
Disadvantages of offset accounts
Despite the benefits, there are also some potential disadvantages of having an offset account. Offset accounts are typically more expensive with a potentially higher interest rate and/or higher fees. This means that you may need to have more cash in the account to negate the increased costs.
To determine whether an offset mortgage is worth it, you should calculate the annual cost and compare it to the expected savings. Alternatively, you can seek the professional advice of a mortgage broker.
What is a redraw facility?
Similar to an offset account, a redraw facility lets you save interest on your home loan. Rather than keeping extra cash in a savings account, you can pay down your home loan on top of the minimum payments to pay off your loan sooner. If you have a redraw facility set up, you can then withdraw the additional payments you have made.
For example, say the minimum annual repayment on your home loan is $10,000. You decide to pay an extra $2,000 each year on top of this minimum payment. This extra $2,000 may be available for you to withdraw at a later date.
Disadvantages of redraw facilities
Redraw facilities don’t act as a transaction account like offset accounts do, so it doesn’t give you the flexibility to access you money in the same way as you could with an offset account.
Having a redraw facility set up with your loan may also mean additional ongoing fees. Additionally, your lender may have limits for how much you can withdraw.