Buying a home is a long term commitment, and you end up paying a lot of money in interest on your mortgage. However, selecting a home loan with the right features can make it easier to manage your loan in the long term and save some money in interest.
Offset accounts and redraw facilities are both common home loan features that could help you save money and build more flexibility into your loan. But which of the two is better suited for you, and how are they different? Let’s find out.
What is an offset account?
An offset account works like your regular transaction account, but it is linked to your mortgage. The money you deposit in an offset account doesn’t earn you any interest. Instead, it is used to reduce the interest you pay on your home loan.
The money in your offset account is ‘offset’ against your mortgage principal, and you are only charged interest on the balance amount. For example, suppose you have a $600,000 mortgage and keep $50,000 in your mortgage offset account. In this case, you’ll only be charged interest on $550,000. Thus, the more money you save in your offset account, the lesser will be the interest charged on your mortgage. However, keep in mind that your repayment amount isn’t going to change, but a larger part of your monthly repayment will be used towards paying off your principal, saving you more in interest over the years and helping you pay off the loan sooner.
While an offset account can help you save money, you may be charged an account-keeping fee or pay a higher interest rate for using this facility. Some lenders might also charge you a small amount each time you withdraw money from the account. Therefore, it’s important to calculate your costs and estimated savings from an offset account to decide whether it’s the right option for you. Generally, using an offset account is beneficial if you can maintain a reasonably large deposit in your account. If you only plan to keep a few thousand dollars, the costs may outweigh the savings.
What is a redraw facility?
A redraw facility allows you to withdraw some of the additional funds you’ve pumped into your mortgage. Let’s assume your monthly home loan repayment is $1,000, but you decide to pay $100 extra each month. This can help you reduce $1,200 from your mortgage annually. Alternatively, you may choose to use your annual bonus or tax refund to make extra payments into your home loan to reduce your mortgage principal and the interest you pay on it. But what if you don’t want to lock in your savings and keep them handy for a rainy day?
With a redraw facility, you can draw on some of these funds to pay for an urgent or unplanned expense. You may be able to take out a personal loan or even use your credit card to pay for such expenses. But you might find it cheaper to dip into your additional loan repayments considering the high interest rate charged on the other alternatives. However, do consider any redraw fee charged by your lender before using this option. You should also remember to use this feature sparingly, as withdrawing the extra funds from your loan will increase your mortgage principal (and the interest you pay on it) again.
An offset account or a redraw facility: what should I choose?
Both offset accounts and redraw facilities are mortgage features typically available on variable rate home loans. You don’t generally need to choose between the two as it’s possible to use both the features simultaneously, but you might have to pay for the bells and whistles on your home loan.
If you need to decide on only one feature, you may consider opting for one that you are going to use more. Both offset accounts and redraw facilities help you save money in interest while allowing you to access your savings when you need to. However, the level of access offered by both is different.
An offset account is essentially like a transaction account linked to your mortgage. You can deposit, withdraw and transfer money to and from your offset account as often you like, though you may be charged a fee by some lenders. Many of these accounts also come with an ATM card, making it simpler to access your money.
A redraw facility may be more restrictive in comparison. A lender may only allow a fixed number of free redraws in a year or put a cap on the amount you may be able to withdraw.
It’s also worth considering your savings in comparison to what you’ll pay for each feature. Choosing an offset account can be helpful if you can maintain a reasonably high balance in your offset account. You should also check for a 100% offset facility, or only a part of your deposit will be used to offset your loan balance.
If you don’t have substantial savings but are disciplined enough to pay a little extra towards your home loan each month, you may want to consider a redraw facility instead. Eventually, the right option for you depends on your individual saving habits and financial situation. A mortgage broker could help you examine both options in detail to decide which one is better for you. They can also help negotiate a lower interest rate or fees on your home loan.
