Does your income provide you with some spare capacity to pay off your mortgage and you’re wondering whether it makes a difference whether you just pay off the principal or use an offset account or redraw facility?
Well, according to studies by Canstar (AFR, 21 Jan 2019) it makes no difference how you do it but paying an extra $125 a week into a mortgage of $500,000 could knock almost nine years from the loan term and save you more than $110,000!
Consider a borrower paying an extra $125 a week on a $500,000, 30-year principal-and-interest loan into either a redraw facility or offset account. Using either option with the same terms and conditions will repay a loan in equal time and save the same amount.
That means borrowers need to consider other issues when deciding whether a redraw or offset fits their needs, such as terms, access to their money and any costs for administration and withdrawals. Fees can range from $5 to $10 a month and some banks charge up to $50 to access funds from a redraw.
A redraw allows borrowers to access the additional payments made into their loan accounts over and above any required minimum payments. Redraws are usually available on all variable rate accounts except, in some cases, for self-managed superannuation funds. They are not available for fixed loan accounts but can usually be accessed at the end of the term.
You’ll need to check whether there is a minimum amount that can be withdrawn, and permission required from the lender, which can delay access to funds. The amount withdrawn must be less than, or equal to, the total amount that has been repaid early. However, we’ve found that most lenders allow funds to be accessed by mobile phone or online banking.
The major selling point of a redraw or offset is the compound interest saved/earned on your repayments because the interest you are being charged on a home loan is likely to be higher than the interest rate on any cash savings account. Additionally, any interest you earn on a savings account is taxed at your marginal income tax rate. The money in the offset is not taxable because it is considered as not generating any interest.
In terms of convenience an offset facility generally has more features.
Money sitting in the offset is at call and accessible compared with a redraw that often requires permission, which means it might not be available on the same day although technology is making redraw funds easier to access with many lenders
Offsets hold any spare savings while a redraw is only available for additional repayments made above monthly requirements. The money in the offset account is offset daily against the balance of the loan account, and this reduces the daily interest charged on the loan account.
Generally, there are no restrictions on the amount that can be deposited and withdrawn but some banks impose fees and charges, which means consistent savings to grow sizeable deposits must be made to make it worthwhile after expenses.
Investors will prefer an offset account as it doesn't upset the tax arrangements should they need to use the surplus funds.
It's a great time to be shopping around for a new loan. Borrowers who meet the income and expense criteria are eligible for a wide range of cheap offers.
(Source: Australian Financial Review, 21 January 2019)