Author: Michelle Griffiths, Partner, Investment Advisory & Wealth
When considering home loan options it’s important to under the difference between a “redraw facility” and an “offset account”.
The difference between a ‘redraw facility’ and an ‘offset account’
From the perspective of the overall affect on the calculation of the interest on the loan, whilst both systems work quite differently the outcome on how much interest you will pay is the same. Therefore, why the difference … well first let’s clarify what they each are:
Redraw facility – is where you can pay off more of the loan than the minimum requirements either in lump sums or on a regular basis (for example paying $100 per month more than your minimum repayments). This reduces the loan amount, and therefore you will only pay interest on the outstanding loan amount – but you can at any time redraw (or withdraw) the amount of additional payments out at a later day without having to apply for a new loan – it is essentially you just getting your additional loan repayments back again.
An offset account is essentially just a bank account where you can put your savings, which is “linked” to your loan account. The calculation of the interest on your home loan is essentially only charged on the difference between these two accounts – for example if your home loan was $500,000 and your offset account was $100,000 – then you are only being charged interest on $400,000, which is the net amount outstanding. Then naturally if you want to use some of the money in your offset account then this is completely available to you.
Whilst the interest calculations work very similarly, there are some significant differences which may make one more appropriate than the other depending on your circumstances.
For tax purposes, if the loan is a tax deductible loan (say for investment purposes) then the offset account works better because if you do withdraw funds throughout the journey then the full amount of the loan will still be fully tax deductible – whereas using the Redraw facility starts making these tax deductibility issues more complex.
From a personal discipline perspective, having the offset account can be difficult for most people to maintain the commitment to. Having this bank account balance can be a bit of an invitation to use this for purposes OTHER than your longer term goals or targets. In my experience they can often be a “trap” – whereas the motivation to “pay off your loan” is better served with a loan re-draw facility. See the loan going down and then it not “feeling” quite so accessible makes it easier to commit to the savings targets that you set.
So ultimately there are the purely financial implications to think about but then also and equally to understand the human side of these decisions, understanding your financial personality and being “real” with yourself and what you are able to do and if you can commit to your savings strategies and work realistically. Work WITH your abilities and motivations, don’t fight these things – as it will only make things harder. Feel free to get some help to understand what is better for your personal circumstances and for the best outcomes for you financially as well as for tax purposes.
This article also appeared in the 1st edition of ERA Magazine.
Compare your existing loan or look for a new one at TAG Finance & Loans home loan comparison website – Compare N Save, it compares 100s of loans to potentially save you $1,000s.
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Disclaimer: The information contained is general in nature. Professional advice should be sought before acting on any aspect on this page. Financial planning services provided by TAG Financial Advisors Pty Ltd (ABN 77 154 205 017 AFSL 415632), a wholly owned subsidiary of TAG Financial Services Pty Ltd (ABN 67 075 374 686). Copyright 2021. Please do not reproduce without the expressed written consent of the author.