If you have a home loan, you’ve probably heard the terms home loan redraw and offset account. Perhaps you’re already making use of one or the other of these arrangements to make extra loan repayments that can reduce the interest on your loan while accumulating extra funds that you can access when you need to.
It’s not uncommon, however, for there to be misconceptions about each of these home loan features. Understanding the key differences is important for making valuable financial planning decisions.
In general terms, a home loan redraw facility is part of a home loan agreement, whereas an offset account is a separate account linked to the home loan.
More repayments, less interest
A home loan redraw facility allows you to pay more than the minimum loan repayment, then should you need extra cash, allows you to redraw up to the total amount of those extra repayments. It can be an effective approach for debt management as it gives you that additional flexibility to pay more when you can to reduce your home loan balance, which in turn reduces the amount of interest you’ll pay, while providing the peace of mind that you can get the money back if you need it.
When using an offset account, extra home loan repayments as well as any surplus cash can be deposited into it and the bank or lender views this linked account as a means for reducing the effective loan balance, and therefore, the interest payable.
If you decide to draw on some, or all of your extra funds held in your offset account, the differences between the two can become more significant.
A lender can impose conditions on the withdrawing funds from a redraw facility, which may include predetermined limits on the amount of funds that can be withdrawn. They can also impose fees or even deny a redraw request entirely.
Linked offset accounts generally don’t have these restrictions, because it’s considered a separate savings account. Even though it’s linked to the loan account, it’s not part of the home loan agreement per se.
Future tax deductibility
Another factor that may come into play down the track is the tax deductibility of your home loan. To help illustrate how this can affect the two different approaches, consider the following example.
Annie is looking to relocate from Victoria to Queensland. She’s hoping to buy a property on the Sunshine Coast while holding on to her existing property in Melbourne. She wants to rent it out to generate additional income and claim tax deductions on expenses including the interest on her home loan.
Her current mortgage is $500,000 and she’s accumulated $100,000 in a redraw facility. She intends to use the $100,000 funds from her redraw facility as the deposit on her new home on the Sunshine Coast.
This means that even though her Melbourne home has been repurposed as a rental property, only $400,000 or 80% of the $500,000 home loan would be considered tax deductible. The other $100,000 or 20% redrawn and used for the deposit on the new family home on the Sunshine Coast property is considered a personal purchase by the ATO.
As the Melbourne home loan balance changes over time, and because the proportion of tax deductibility remains fixed at 80%, it will mean Annie will not be able to separate and repay, the non-deductible debt before the deductible debt.
Every dollar of repayment will reduce both the non-tax deductible AND the tax-deductible parts of the loan, which goes against a common debt strategy of repaying the non tax-deductible part of the debt first.
If Annie had opted for a linked home loan offset account, the $100,000 amount could still be used as a deposit for her Sunshine Coast home, but with a significant difference.
As the offset funds are separate from the $500,000 Melbourne home loan, once the loan is repurposed for a rental property, the full balance of the offset account ($100,000) can be used for a new property deposit (or any other purpose for that matter) as it is separate from the rental property loan which becomes tax deductible.
This situation would also allow Annie to pay down her non-deductible debt (the loan she took out for her Sunshine Coast property) as quickly as possible, while benefiting from the tax-deductible entitlements of the Melbourne rental property home loan.
The example above highlights just how valuable it can be to share your lifestyle plans with your financial adviser. While we collaborate with other professionals, including tax advisers for advice and implementation of tax strategy, as you can see here our considerable knowledge of these and other matters, enables us to provide valuable insights and guidance that can help you to achieve your overall financial goals faster and often with better outcomes.
Your next steps…
At Stratus our approach is to arrange regular progress meetings. During these meetings we review your financial progress, and we also ask about changes in life’s circumstances and whether any goals have changed or been added. This additional information can often initiate changes in your financial strategy.
In our experience, clients who are working towards and achieving their goals and those things that really matter to them, look forward to progress meetings. Prior to attending, they take a moment to think about where they are now – stage of life, work, health, family – and where they would like to be so they can share any concerns and their aspirations with us. Importantly, for partners, rather than leaving it to one, both attend and contribute to the discussion.
Of course, you don’t need to wait until your progress meeting to contact us. As we like to say around here, when it comes to achieving what really matters, we here to help you Make it Happen!
Stratus Financial Group and its advisers are Authorised Representatives of Fortnum Private Wealth ABN 54 139 889 535 AFSL 357306. This information does not consider your personal circumstances and is of a general nature only. You should not act on it without first obtaining professional financial advice specific to your circumstances.
*Please note: Credit advice is not offered under the Fortnum Private Wealth AFSL. When required, we refer to appropriately qualified professionals.