Both redraw facilities and 100% offset accounts can help to reduce the interest incurred on your loan, but they work in different ways. Let’s take a closer look to see which option might be appropriate for you.
What is redraw and how does it work?
A redraw facility allows you to make additional payments into your home loan, and then access these funds should you wish to take them out of the loan at some point later in the future.
For example, just say you received inheritance of $50K and paid this as a lump sum amount into your $500K home loan. Whilst these funds are sitting in your loan, the interest you are charged should be calculated on the balance of $450K. The lump sum payment has reduced the balance of your loan and lenders calculate the interest owed on your loan balance.
If redraw is active on your loan, assuming there are no restrictions in place from your lender, you can access (or redraw) this $50K at any time you want, to spend however you want. Once the lump sum payment is taken out however, the balance of your loan will increase back to $500K (we’re assuming there’s been no reduction to the principal for ease of explanation here) and as such, interest charges will increase accordingly.
It’s important to note some lenders have restrictions around redraw and sometimes, it’s not clear as to how much interest you’re saving by parking funds into your loan.
What is an offset account and how does it work?
A 100% offset account is a savings account you have with the same lender as your loan. The balance of this account is offset against the balance of your home loan, so any funds you have sitting in this account help to reduce the interest incurred on your loan.
For example, if you have a home loan balance of $500K and a 100% offset account balance of $50K, the lender will charge you interest on $450K – i.e. the net amount of your debt after the balance of your offset account is taken into account.
In this way, the interest you can save using an offset account are typically the same as if you were parking funds into your loan itself. The $50K in offset may arguably be easier to access – depending on redraw restrictions/ functionality of your lender. But most lenders will charge you an annual package fee to have access to an offset.
You can find more about offset accounts and how they work here.
What are the longer-term implications of selecting redraw vs offset?
When comparing redraw facilities and offset accounts, it’s important to consider the potential future tax implications of each option.
With a redraw facility on a home loan, any additional payments you choose to make will reduce the principal on your owner occupier loan (non-deductible debt) and therefore have no immediate tax implications.
But let’s look at what happens if you redraw the $50K back out in the future and use these funds as a deposit for a new owner occupier purchase. At the same time, you decide to turn your existing home into an investment property.
Well, the loan balance will increase back to $500K (again, we’re not considering principal reductions over time here). But since you have used $50K of this $500K loan to help purchase an owner occupier home (i.e. non income producing asset), you have technically mixed the purpose of the $500K loan. This means you’re likely to run into issues if you plan to claim the interest costs you incur on the full $500K loan going forward.
With a 100% offset account however, you’re keeping the funds entirely separate. This means that when you use the $50K you have saved (that’s been sitting in your offset account) to help you purchase a new property, the loan balance/principal amount on the your loan isn’t affected at all.
In this offset example, the loan balance has always been $500K. You’ve just been using the offset account as a way to help reduce the interest you pay. Sure – when the $50K is spent, the interest costs will increase – because there are no funds in offset to reduce the interest costs. But once the property is rented, this $500K loan will be an investment/ deductible loan anyway.
As you can see, there’s a lot that goes into ensuring you select a loan that has the right features. Sure, we want to ensure the loan structure suits you now. But if you have longer term property plans, we also want to ensure things are set up to help you maximise financial benefits over time.
** This does not constitute taxation advice, we are not qualified to give taxation advice and recommend you to speak to an accountant about your personal taxation matters. Tax laws, regulations and loan features are always changing and there will be specific tax implications that may vary in accordance with your individual circumstances. We’re merely raising points here for you to consider and suggest you investigate these further with a qualified tax accountant should
