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When it comes to managing your mortgage, the right financial tools can make a significant difference in how much interest you pay over the life of your loan.
Two important features to consider are offset accounts and redraw facilities. While both can help reduce the amount of interest you pay on your mortgage, they work in different ways and come with their own sets of pros and cons.
So, how do you choose between an offset account and a redraw facility?
What is an Offset Account?
An offset account is a transaction account linked to your home loan. The balance in this account is used to “offset” the outstanding loan balance, reducing the amount of interest charged.
For example, if you have a $400,000 mortgage and $50,000 in your offset account, you’ll only be charged interest on $350,000.
Offset accounts come in two types:
- 100% offset: provides a full interest-saving benefit,
- Partial offset. offers a reduced interest rate on the portion of the loan equivalent to the balance in the account.
Potential Benefits of an Offset Account
Interest Savings: The most significant advantage is the interest saved on your mortgage. Every dollar in your offset account reduces the interest payable on your loan, which over the long term can save you years of repayments and quite a significant amount of money.
Liquidity: Funds in an offset account are easily accessible. You can deposit and withdraw money as needed without impacting the offset benefits. This makes it a convenient option for managing your everyday finances.
Tax Benefits: Interest saved through an offset account is not considered income, making it a tax-effective way to use your savings. This can be particularly beneficial for those in higher tax brackets.
Flexibility: You can have your salary and other earnings deposited directly into the offset account, maximising the interest-saving potential.
Potential Drawbacks of an Offset Account
Fees: Some offset accounts come with higher fees, such as monthly account-keeping fees or transaction fees.
Interest Rates: Generally, loans with offset accounts may have slightly higher interest rates compared to those without this feature.
Minimum Balance Requirements: Some lenders may require a minimum balance in the offset account to activate the offset feature, which could be restrictive.
What is a Redraw Facility?
A redraw facility allows you to make additional repayments on your home loan, reducing the loan balance and the interest charged. Unlike an offset account, these extra repayments are made directly into the loan, lowering the principal. If you need to access this extra money in the future, you can “redraw” the funds, subject to the lender’s terms and conditions.
Potential Benefits of a Redraw Facility
Interest Savings: Similarly to an offset account, making extra repayments reduces the principal on which interest is calculated, leading to significant interest savings over time.
Lower Fees: Loans with redraw facilities typically have lower fees than those with offset accounts. In many cases, there may be no additional cost for having the redraw facility attached to the loan.
Lower Interest Rates: Loans with a redraw facility often have lower interest rates compared to loans with an offset account.
Encourages Savings: Because accessing the funds requires a more deliberate action, a redraw facility can encourage better savings habits by reducing the temptation to spend money that could otherwise reduce your loan.
Potential Drawbacks of a Redraw Facility
Limited Accessibility: Redrawing funds is not as simple as withdrawing money from a transaction account. There may be waiting periods, limits on the amount you can redraw, or even fees for accessing your money.
Less Flexibility: Because the extra repayments are made directly into the home loan, any withdrawals will impact the interest-saving benefits. This lack of flexibility may not suit those who need regular access to their funds.
Potential Restrictions: Some lenders may set minimum or maximum redraw amounts, limit the number of redraws per year, or charge fees for redrawing funds.
Which One is Right for You?
This decision is tied into your financial situation, spending habits, and future plans. Each feature offers significant advantages for mortgage holders looking to reduce the amount of interest they pay and potentially pay off their mortgage sooner.
Try asking these questions when considering which strategy is right for you:
- Do I value flexibility and accessibility?
- Do I want to minimise fees and interest rates?
- What are the tax implications?
- Do I want to go through and compare the ins and outs of the terms for various lenders?
If you answered no to the final question, then consider consulting with a mortgage broker who is across a panel of over 35 lenders and is already deeply experienced with the ins and outs of each lender’s suite of home loans. A mortgage broker tailor a strategy that works best for you.
