When you apply for a mortgage, there may be jargon that your lender talks about that you don't quite understand. They may start throwing terms around like "amortization", "5 year fixed rate", "mortgage offset", or "redraw facility".
The latter two are what we'll cover today. The two terms; mortgage offset and redraw facility - are sometimes used interchangeably. This shouldn't be done as they are not the same thing. For one, an offset is an account that's linked to your mortgage and a redraw facility is a feature attached to your home loan and not an account.
The Mortgage Offset Account
What is a mortgage offset account?
An offset account is a transaction account linked to your home loan. You can make deposits or withdraw from it as you would with a regular transaction account.
The big difference is that when you hold money in an offset account over a period of time, you can reduce the amount of interest charged on your home loan. The higher the balance and the longer the period, the less interest you’ll pay. And this could help you pay off your loan sooner.
Generally speaking, the offset feature is only available on variable rate home loans (although some lenders offer an offset feature on selected fixed rate home loans). An offset account is not an option in the US as their tax laws do not allow it.
How does an offset account work?
Interest is calculated on your home loan balance minus the balance kept in your offset. So if, for example, you have a loan balance of $300,000 and $50,000 in your offset account, you’ll only pay interest on $250,000 of the loan balance.
The higher the balance is in your offset, the more you’ll save on your home loan because interest will be calculated on a lower overall loan balance.
How to use an offset account
If your bank allows you to open multiple offset accounts, you may choose to allocate one account towards your bills and regular expenses, another towards your everyday spending, and so on. Some banks charge fees for offset accounts or have limits on how many you can open, so always check the terms and conditions before opening one.
Some people may have their pay deposited straight into their offset account and treat it as an everyday transaction account. Others may use their offset as a savings account for things like holidays or renovations – or for less exciting purposes like setting aside money for their tax bill.
What's the benefit of using an offset account over a regular savings account?
Your money generally works harder in an offset account compared to a regular savings account. That’s because the interest rate you pay on a home loan is usually higher than the interest you earn in a savings account.
Another advantage is the interest you save by using an offset account won’t be considered income – which means it won’t be taxed. On the other hand, the interest you earn on a savings account will generally be considered income – and that means it may be taxed. And we all hate the idea of paying extra taxes!
The Redraw Facility
What is a redraw facility?
A redraw facility works in a similar way to an offset account, but there are some important differences. While the offset is an account that's linked to your home loan, a redraw facility is not an account. The redraw option is a feature that's attached to your home loan that lets you access extra principal repayments you've made on your loan.
This could come in handy if you need some extra money in the future. Similar to the offset, maintaining an available redraw balance can help reduce interest on your home loan.
How does a redraw facility work?
When you've bought your home and you're in the rhythm of paying the regular mortgage repayments, there might come a time when you want to throw a little bit more toward the mortgage balance, either as a one-off or more frequently.
If something unexpected happened in your life, and there were an expense attached to it, you might feel like throwing your hands in the air and hope it just disappears. We know that it likely won't disappear, so it's always handy to have some money set aside in case of emergencies.
This is where a redraw facility can come in handy. If you've been paying extra amounts towards your mortgage and have the redraw option, you can withdraw the extra balance to cover your expenses.
How to redraw money
It's usually pretty easy to redraw money, assuming you have sufficient balance to do so. While every lender may have different options, most will let you request a redraw through their online banking portal, via a phone call, or by visiting the branch.
It's important to note that different lenders will have different minimums and maximums you can withdraw with the redraw facility. It's always best to check the T's & C's to fully understand the product or service.
Redraw vs Offset accounts
Both can help you reduce the amount of interest you pay on your home loan
Both are generally available on most standard variable loans
Both can help you pay your loan off quicker
You can withdraw from both relatively easily (assuming you money in there)
An offset is an account. A redraw facility is a feature attached to your home loan.
Tax implications may be different if you decide to rent out your house in the future.
Both accounts can work together. It doesn't have to be an 'either or' thing
Just like a lot of things in this world, you don't necessarily have to settle for one without the other. Many people use both offset accounts and redraw facilities.
One reason where this would be practical would be if you wanted to make extra payments to your home loan each month through a redraw facility, and also select an offset account as your everyday transaction account where your salary is deposited.
Both accounts will help reduce the home loan interest, and both can help you pay your loan off quicker.
A decision that's right for me will not always be the best decision for you, so it's important to understand your own situation, finances, goals and objectives before selecting a product or service to suit your needs.
Offset accounts and redraw facilities both have the potential to save you interest on your home loan, but there are key differences like we've mentioned.
An offset account works much like an everyday transaction account. You can withdraw money at an ATM and buy things using a debit card. It's also easy to transfer money in and out of. You could even choose to have your entire salary deposited into an offset account.
A redraw isn't an account, rather it's a feature that's attached to your home loan for the purposes of redrawing extra mortgage repayments. It doesn't give you the flexibility to access money the same way that an offset account can.
Depending on how well you handle money, having less access can be a good thing, as you'll be less likely to touch it unless it's an emergency.
Given that the redraw has limited flexibility compared to the offset account, my vote would be the offset account as the winner in this challenge.
Blake - FIRE with a family