There’s a couple of differences between offset and redraws for your mortgage, and I want to take the time to make sure you understand them.
WHAT IS AN OFFSET?
An offset account is a separate bank account to your mortgage (home loan) account. You will have 2 accounts, and one is a savings account, and the other is what you owe to the bank.
Most banks will allow you to have an offset account, and some banks allow you to have multiple offsets against your mortgage.
An offset account is a separate stash of money that helps you reduce the amount of interest on your home loan each month. If you have a savings strategy to make your offset account match your loan amount, you can track the amount of money in your offset and watch it grow over time until you hit that goal.
The more you have in your offset account, the quicker you will pay off your loan, because more of your monthly repayment is going towards the principal and less is going towards interest.
JARGON ALERT: PRINCIPAL VS INTEREST
Principal is the amount of the loan you have borrowed. Interest is the amount that the bank is paid by you for lending you the money. Over the first few years of a loan, your repayments might look something like $4000 = $3800 interest & $200 principal – which means that your loan balance only has reduced by $200 instead of the $4000 you have paid. The more you pay off your loan, the quicker it switches, so soon it will show on your bank statements as repayments of $4000, interest $1600 and principal $2400.
If you have an offset account with money deposited in it, this balance will help to reduce the interest that the bank charges, and your principal will be repaid more quickly.
If you are lucky enough to have multiple offset accounts available, you can use these as savings buckets for things you are less likely to spend money on regularly – such as a deposit for a new house or a holiday, and keep that money separate from other spending.
A major benefit of an offset account is that you do not change the nature of the loan if you spend some of that money, because the loan and the savings are two separate amounts.
If you do start to spend the money saved in your offset, then this will start to increase your interest again.
If you have worked towards getting your offset account to the same amount as the loan balance, then there will be no interest charges on that loan, and your repayments will pay down the principal amount until the loan is fully paid off.
WHAT IS A REDRAW?
A redraw is the ability for you to take out additional payments you might have made towards your loan.
For example, if your bank’s minimum repayments are $2890 and you round it up to pay $3000 per month, then the extra $110 you pay above the minimum repayment amount will be added to your redraw balance. You might see this on your internet banking as an “Available” amount.
If you make multiple overpayments, then your redraw amount will increase over time. However, you still only have one account – it’s just the mortgage you are paying off. Any savings are held inside of your loan, and the only way to get it out is to “redraw” from the loan, and increase the loan balance again. This results in higher interest and may potentially change the purpose of the loan for tax purposes (if your property is rented out now or in the future).
One of the benefits of having a redraw if you no longer want or need access to that money, is that you can ask the bank to close off the redraw amount, and the loan balance will be a smaller amount & likely lower repayments to make. This is important if you are going for other financing (even though you have paid a bucket load off, the banks still see your loan as being the full amount owed as per the schedule – because you could turn around tomorrow and pull it all out again, even if you don’t).
HOW MUCH DO I OWE THE BANK?
The easy answer “it depends”. Different banks have different ways of reporting your loan balance. Some will say your loan balance is $500,000 with available redraw of $46,000 – and this means you actually owe $500,000. For other banks this will mean that you owe $454,000. It’s important to look at your bank statements and not just your internet banking to figure this out.
Your interest is charged on your loan balance, less your offset (if applicable).
SO WHICH IS BETTER?
It depends on your personal circumstances – I prefer the flexibility of an offset account as the loan purpose is not changed over time, however there is simplicity in having a loan that’s been paid off quickly – especially if you don’t need the money later on.
