If you have done any research into home loans, you would have heard of the term “Offset Account”. This has been touted as one of the best way to manage your home loan, since it lets you use your savings to reduce the interest you pay without affecting that savings at all. While Offset is indeed a very effective tool, it is not the whole story. There is an often overlooked alternative that is potentially cheaper but just as effective, called 'Redraw'.
Today, we will explore how each of these options compare with each other, so that you know which is more suitable for your situation.
Redraw
If you have a variable loan, most likely you already have Redraw because it is a built-in feature with most variable loans nowadays.
Using Redraw is as simple as paying more than the minimum amount required, which will create an available balance in your loan. This balance reduces the outstanding balance of your loan, thus reducing the interest you pay.
You can also take this money out without restriction or fee, and at any time. Simply transfer the amount you need from the loan account to a daily transaction account and it will be available within a day or two.
Since it is built-in, there is no extra cost to have Redraw. Better yet, the banks typically offer their lowest variable rates with basic loans, making these some of the cheapest variable options available.
Let's look at an example of a $500,000 mortgage below. If you have $100,000 to keep in Redraw, it will greatly reduce your interest.
Offset
The main function of Offset is very similar to Redraw, in that it reduces an identical amount of interest.
The main difference is that it is a separate account opened alongside the loan, with the money always available at any time. You can withdraw at ATMs, make purchases, and set up automatic payments directly from Offset without first having to transfer to a different account.
Yor salary can also be paid into this account, removing the need to manually increase your Offset balance. This can be replicated with Redraw but it is still a convenient feature.
For its convenience, Offset is often more expensive than Redraw. All banks charge additional fees for Offset accounts, ranging from $8 per account to $395 annually on multiple accounts. Many banks charge higher interest rates (usually about 0.15% higher) for loans with Offset accounts. These tend to be smaller banks with cheaper rates so the difference is even more noticeable.
Managing Offset can also be more complex than Redraw, since each loan has to have its own Offset account. You can have multiple Offset accounts for one loan, but you cannot have one Offset account for multiple loans. This may sound trivial at first but can be overwhelming once you get your first or second investment property.
Below is the same example but using Offset instead.
Tax Deduction
One of the most misunderstood differences between Redraw and Offset is how they affect your tax deduction on an investment property.
In Australia, any expense on an investment property is tax deductible, including interest on your mortgage. When you put money into either Redraw or Offset, this interest is reduced but also your tax deduction.
When you later withdraw some of that money, whether it is from Redraw or Offset will make a difference. If it is a) for personal use and b) withdrawn from Redraw, your interest payment increases but you do not get the tax deduction back. Offset does not have this problem, you always get tax deduction from interest payment regardless of how you use your money in Offset.
Keep in mind that tax deduction only applies to investment properties. For your own home, there is no tax deduction so this difference does not apply.
Bringing it all Together
The ability to reduce interest charge is exactly the same between Redraw and Offset. The difference is in its execution and tax implications.
Redraw is much simpler to maintain, especially if you have multiple loans. It also has no cost and more importantly, often have the cheapest variable rates. On the other hand, Offset is more convenient to use as there is no manual transfer involved.
Since accessing Redraw is not as convenient, you should treat it as a savings account and only take money out when planning a big expense. If you prefer to always have access to your savings, paying extra for an Offset account can be of value.
If you don’t have any cash remaining after the purchase, paying for an Offset account is useless especially if it also comes with a higher rate. In this case, it is better to just have the free Redraw and add cash when you have any extra.
It can feel overwhelming when choosing between Redraw and Offset. Below are a few recommendations you can consider based on your situation:
For your own home, it is usually recommended that you just go with Redraw. Since there is no tax deduction, you are not getting the most important feature of Offset with this loan. Therefore, minimising cost is the most important factor, which makes Redraw the best option. Accessing cash in Redraw may take an extra day, which is hardly a concern when you consider the cost savings.
If the property is an investment though, it can be better to go with an Offset account. The tax deduction rules can make a big difference if you have the savings to take advantage of it.
If you have your own home and a number of investment properties, it may be better to have all loans on Redraw and only put your savings into your owner-occupied loan. This minimises interest on your home (which is non-deductible), while avoiding fees and high rates on the remaining properties. Once you have completely paid off your main home, it is easy to add an Offset account to one of your investment properties and start paying that down.
Be sure to leave a comment if you have questions and I will do my best to answer them. Until next time, stay sensible.
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