Chances are if you’re looking to buy your first home, you’re probably also starting to look for your first mortgage product and comparing the different options available. Many home loan packages will include options for either an offset account or redraw facility or both, but if you’re just starting out you might be confused what the difference is between the two. While on the surface, both options give you the ability to lower the interest on your loan (making your repayments lower over time), there are key differences that are worth noting when comparing your options.
A redraw facility is a feature added to some loan products that lets you make extra principal repayments on your loan, while still giving you access to these funds if you need them.
For example, let’s say your minimum home loan repayments are $1,800 per month, but you decide to chip in an extra $200 each month to make your repayments $2,000 per month. By doing this you’re not only lowering the interest you pay by lowering the outstanding loan amount your interest is calculated against, you’re also making an extra $2,400 per year in repayments. If left untouched, these additional repayments can make a significant dent to your debt over time and reduce the life of the loan.
A redraw facility also gives you the flexibility to withdraw these extra repayments made on the principal of the loan (i.e. the bit of your loan that’s owed on the purchase price of the property, not the interest the bank charges on top), if you ever need the funds for something else. You just need to be mindful that any money you take out of the loan will increase your interest repayments and add back any time you would have saved on the life of your loan.
While a redraw facility is a feature that sits inside your mortgage, an offset account is a separate bank account similar to a savings account that sits outside your mortgage. Even though an offset sits as a separate account, it is still linked to your loan so that any funds you add to it will offset the balance of your loan to lower the interest repayments you owe on it.
For example, let’s say your outstanding loan balance is $520,000. You’ve been working hard to save, and you’ve amassed $20,000 that you put into your offset account. Because the offset sits alongside your home loan, the bank will consider the funds you have in this account to calculate the interest they’ll charge. Interest will be charged on your loan balance minus the amount in the offset (which’ll end up being $500,00 in this scenario), as long as the funds exist in your offset.
The benefit of an offset existing as an account outside your mortgage is that it’s easy to transact from, so you can take out money from it at any time. However, just like in the redraw example, taking out money will not give you the benefit of the lower interest you’ll be charged.
It’s also worth noting that unlike a redraw facility, the life of your loan will not go down with money you add to the offset as these funds are not treated as additions loan repayments. The money in this account simply acts as an offset for interest calculations.
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The choice between an offset or redraw will be different for each person depending on your circumstances.
If you’re looking to reduce the life of your mortgage and pay down your home loan faster, then a redraw facility might be exactly what you’re looking for. It’s also a good option for those who don’t want to be tempted to spend the extra repayments they make – even though you can withdraw from the additional repayments you make on the principal of your loan, because the funds are tied up with your mortgage it might take a little longer to access the funds (you can’t just go to an ATM and take it out as cash). The downside is that there’s also often a transaction fee associated each time you request funds from your redraw, so you’ll need to be mindful not to draw down too often.
If you’re keen to lower the amount of interest you’re charged but also want to be able to easily access your funds immediately when you need them, an offset account is more likely the option for you. To make the most of your offset, you could even have all your pay contributed to the account (because interest is calculated daily, you’ll be saving quite a bit of interest with larger deposits made), and still have the confidence that you’ll be able to access the funds straight away. The downside is that to get an offset account you’re usually going to be charged a monthly fee to maintain it (or an annual fee if it comes as part of a home loan package).
Another consideration is that if you even intend to move out of your first home and make it into an investment property down the line, the tax implications of an offset and redraw are different so it’s best to speak with an expert.
Whatever you choose, it’s important to weigh up whether any benefits you might get by reducing your interest or paying down your loan faster are going to outweigh any potential fees you’re charged by leveraging these options. To learn more about whether adding an offset account or redraw facility to your home loan is going to be right for you, speak to the team at First Things First today.
Note, this blog is general in nature and has been prepared without taking into account your objectives, financial situation or individual needs. You should, therefore, consider the appropriateness of the information through independent means before acting on any of the information provided.