So you’ve read through our getting started in property article and have made the plunge. But which account is actually better an offset or a redraw? Let’s jump into it in Prophet Invest’s latest collaboration from Money with Dan. This is Redraw VS Offset Account.
Is an offset account worth it?
Have you bought a residential property or are in the middle of refinancing an existing mortgage? Are you trying to choose between a redraw only loan or an offset account?
Knowing the right time to use an offset account or a redraw only account can potentially save you over 250k in interest costs on an average loan over a 30 year term, or help you to pay it off 10 years earlier! So YES! This article is worth the read.
In this article we will take a closer look at the pros and cons of a Redraw only Loan account vs an offset account to see which is better and when.
Disclaimer: it is important to note here that the information in this article is for general information and entertainment purposes only and is not a replacement for professional advice. Money with Dan and Prophet Invest are not financial advisors. You should consider seeking independent legal, financial, taxation or other advice to check how the information in this article relates to your unique circumstances.
Redraw VS Offset Account: What is an Offset Account?
An offset account is just like a normal transaction account that you pay your bills with and have your salary deposited into and also allows you easy access with a debit card. The balance in an offset account is also guaranteed by the Australian Government up to $250,000 per bank! Source: APRA.
The main difference with a normal transaction account and an Offset account is that instead of being paid an abysmally small amount of interest income you get to save interest on your loan at your very high mortgage interest rate. And since this is money you’re ‘saving’ rather than ‘earning’ it’s tax free!
However, the major benefit with an offset account is that it is YOUR money, not the banks money, so you can access it anytime you like!
Redraw VS Offset Account: What is a Redraw Only Loan?
A redraw only account allows you to draw down money from the extra repayments you have made above your minimum loan repayments compared to your remaining loan term.
You see, with a redraw account, it’s NOT your money anymore as you have paid down the loan quicker than what is required.
So as you pay down your redraw only loan, so too does the amount you can redraw out of your loan.
Also with a redraw account you will need a separate transaction account to pay bills and have your income deposited into unlike the offset account.
Redraw Vs Offset Account: Interest Rates
If you’ve used a mortgage rate comparison website, you may have noticed that all the cheap home loan rates with variable interest rates are from smaller bank or non-bank lenders that don’t have offset accounts.
You may have also noticed that the difference in interest rates for a home loan with an offset account and one without one at the same bank could be more than 1% especially at all the big 4 banks.
In the following table we have summarised the difference of the standard variable interest rates charged using a sample of the big 4 banks, one non-bank lender and one medium sized bank. The loans rate are the advertised rates as of 18th May 2021.
|Offset||Offset||No Offset||No Offset|
|Bank||Variable Rate||Annual Fee||Variable Rate||Annual Fee||Rate Difference||Fee Difference|
|CBA||3.85%||$395||2.69%||$ –||1.16%||$ 395|
|NAB||3.56%||$395||2.69%||$ –||0.87%||$ 395|
|Westpac||3.29%||$395||2.29%||$ –||1.00%||$ 395|
|ANZ||2.99%||$395||2.72%||$ –||0.27%||$ 395|
|ME Bank||3.07%||$395||2.58%||$ –||0.49%||$ 395|
|Macquarie Bank||2.49%||$248||2.49%||$ –||0.00%||$ 248|
Overall, you can see the biggest difference is a huge 1.16% with the CBA offset account compared to its Redraw only option while Macquarie Bank had no difference.
Although Macquarie Bank has no interest rate difference between its offset and redraw only product, Macquarie Bank’s redraw only option is not the lowest. Westpac’s redraw only option is the lowest overall in this comparison with an interest rate of 2.29%.
Also, the annual fees apply only to offset accounts and they are a hefty $395 in this sample, except for Macquarie Bank which has a lower fee at $248 per year.
Mortgages with offset accounts in Australia comprise about 45% of the total value of residential mortgage debt according to an RBA study in 2019.
So there must be a valid reason to choose an offset account, instead of a redraw only account, despite the obvious difference in interest rate at some point in time right? Or is there?
Why use an Offset account?
Whether you need an offset account or not, typically depends on one of the following situations:
The first reason will depend on whether you intend on changing the use of the property to a rental property in the future while it is still mortgaged.
A common scenario is a first home buyer who starts off with a small property in a less desirable area who plans on trading up to something bigger. If they plan to keep the smaller property and turn it into a rental property they could benefit from having an offset for tax reasons.
The tax benefit could potentially be if they withdrew the balance in their offset account for a deposit on a new home. The withdrawal of the balance in the offset account would mean they could potentially claim all the interest expense as a tax deduction which would reduce their taxable income.
Now, if they had a redraw only account and they redrew against their existing loan that was paid down while they lived there, then the tax deduction on the interest expense may be limited to the amount on the remaining loan balance before they redrew the money from the loan. This would mean less interest expense could be claimed as a tax deduction.
The tax implications and benefits could vary significantly depending on the circumstances obviously expert tax advice is recommended.
2. Access to Cash
If you want unlimited access to your extra loan repayments, then a redraw only loan usually has more limitations on how much you can access and when.
This is usually at the discretion of the bank allowing you access to those funds. Remember the redraw is not a transaction account.
On 4th May 2020, ME Bank took away money from redraw accounts at their own discretion which was right at the middle of an economic crisis caused by the pandemic. Which obviously lead to panic!
If you lost your job and were depending on accessing your emergency fund from your redraw account back then you may have faced uncertainty or challenges. In the end, the decision was reversed after pressure was applied. However, if we had a more prolonged crisis this issue could have been more widespread across other banks and there is less certainty of what would happen.
What If you need Certainty with a Redraw loan account?
If you need certainty of accessing funds whenever you want, then keeping all your spare cash in the redraw is not the best place as you don’t have the same control.
However, you could leave a set amount of cash in a separate savings account for emergencies only, say 3 to 6 months’ worth, where you can access at any time. Check out our Personal Fianance 101 Article.
The downside of this is that a savings accounts always pay a lot less interest income than the amount you would save if those funds were applied against your mortgage.
How to Make an Offset Account Worth the Extra Cost?
How much money would you need to have in your offset account to make up the difference in the higher interest rate you are paying compared to having a redraw only loan account with an emergency account in a separate savings account?
Well it turns out quite a lot in fact! It varies from bank to bank obviously but can be around $30K-172K
If you don’t plan on making lots of extra repayments and don’t think you will have tax issues, then an offset doesn’t make a lot of sense and a Redraw only might.
If you want to see the results of how much money you would need with the 6 banks I have compared for an offset account to make sense, then check out my video in the link below: