When applying for home loan, looking for the cheapest rate can only get you so far — loan features like offset accounts and redraw facilities are actually the ones which make a big difference as you start paying your monthly dues.
If you are a diligent saver, an offset account and a redraw facility will definitely help you in your repayment journey. Theoretically, both home-loan features allow you to reduce the balance of your loan and cut the amount of mortgage interest you will pay. If combined with the ability to make extra repayments, these features will help you settle your loans in a significantly shorter amount of time.
But which of the two suits your needs? In this guide, Your Mortgage tackles everything you need to know about offset accounts and redraw facilities.
An offset account is a savings or a transaction account that is linked to your home loan. It operates as a regular transaction account and gives you ready access to a pool of funds.
The beauty of an offset account lies in the fact that the amount of money in it is accounted daily against your loan balance, cutting the mortgage interest charged to you.
Imagine that you have a $600,000 home loan with a 3.9% interest rate and an offset account linked to the loan with a balance of $50,000. If your lender allows you to have a full offset account, then the interest rate will only be charged to $550,000 of your home loan. Some banks, on the other hand, only offer a partial offset.
You can also look at it this way. Offset accounts operate like a high-interest savings account. Any interest earned on your offset account is deposited into your home loan account, reducing the interest charged.
One trick borrowers use to ensure that they get the most out of their offset accounts is paying their salaries into it. Some even use their offset accounts as their savings account, where they build an emergency fund that they can use on a rainy day. The more you save, the bigger portion of your loan is going to be exempted from the interest-rate charge.
Offset accounts are typically only offered on variable home-loan rates or on the variable part of a split loan.
A redraw facility is a home-loan feature that allows you to withdraw the extra repayments you made towards your loan — for a fee, of course.
Let's say instead of paying the required $1,500 monthly repayment, you decided to pay $1,700. The extra $200 will build up over time, creating a pool of funds that you have access to. If you consistently pay $1,700 for five years, you will have made $18,000 worth of extra repayments.
You can also make big extra repayments. If you have an extra $10,000 to spare, you can use it as an additional repayment to your loan. You will still have access to that amount whenever you need it — be it for a car purchase, a home renovation, or a big life event.
In terms of accessibility to funds, how do offset and redraw differ?
While the two work the same way theoretically, the way you access the pool of funds is one of the things that make the two quite different from each other. Accessing funds in an offset account is instantaneous, given that it works just like a savings account. You can withdraw it anytime, anywhere using an ATM or phone banking.
On the other hand, banks typically charge borrowers who withdraw their extra repayments through a redraw facility. Others impose restrictions, limiting how many times you can make redraws and how much you can withdraw.
How can an offset account and a redraw facility help you pay off your loan?
These home-loan features are great additions and can help you save money. Each, however, has its own way of helping you pay off your loan.
If you want to reduce interest on your loan while maintaining instant access to your funds, choose a home loan with an offset account. Take note that the amount of money in your offset account is not considered an extra repayment — this means that it will not reduce your outstanding balance as extra repayments from a redraw facility do.
Offset accounts work well for those who want to cut the charge the interest rate makes to their loans. They are for borrowers who want to save but don’t necessarily want to pay extra on their principal. Offset accounts are also for people who want instant access to the extra money that they have.
In contrast, a redraw facility is perfect for borrowers who want to pay off their mortgage earlier. If your home loan has a redraw facility feature, the extra repayments you make pay off part of your principal. A redraw facility not only helps you reduce the interest charged to your loan but also helps you shave years off your loan term.
Which will work best for you — an offset account or a redraw facility?
It all boils down to your personal preference. If you want more flexibility and you do not necessarily plan on paying your mortgage early, consider finding a home loan that has an offset account. However, if you want to focus on paying off your loans early, then look for a mortgage product with a redraw facility.