Offset Accounts v Redraw Facility or LOC

There are many methods for Australian Expats living overseas and those on Temporary Resident or Spousal Visa’s to pay their home loan (mortgage) off earlier. Over the coming months I will explore a few of these but this month we are looking at using an offset facility v a redraw facility or line of credit (LOC).

1)      What is an offset account

2)      What is a redraw facility,

3)      What is a line of credit facilty (all in one account).

 1) What is an Offset Account?

An offset account is generally a standard transaction account that you would normally use to have your pay deposited into and pay for your groceries, fuel etc by using the debit card attached to the account. This transaction account becomes an offset account when it is attached to a home loan and is said to “offset the interest in that home loan”.

To understand this it is important to note that banks in Australia calculate the interest payable daily and will charge it to you weekly, fortnightly or monthly. When funds are in an offset account they are taken to be in the home loan account therefore offsetting that balance.  It’s kind of hard to explain but here is an example:

If you have a home loan balance with MAP Bank for $200,000 at a rate of say 5%.  $200,000 @ 5% is $10,000 in interest per year.  Divide that by 365 days and you are paying roughly $27.40 per day in interest. However, if you have an offset account with say a balance of $20,000 then every day that $20,000 is in there, interest is only being calculated on the loan balance ($200,000) less the amount in the offset account ($20,000) so $180,000.  $180,000@ 5% = $9000 per year.  Divide by 365 days = $24.66 per day in interest.  This $20,000 in the offset account is therefore saving you about $3 per day in interest.

This is how an offset account works, it reduces the interest payable.  If you are paying principle and interest repayments then your repayments will still stay the same so more of your payment will be going to cover principle rather than the months interest bill.  

2) What is a Redraw Facility?

Most variable home loans and some fixed loans permit the payment of extra payments and the redraw of those extra payments if you need them.  Eg, in the example above if you had $20,000 but did not have an offset account, you could just deposit this $20,000 into the home loan and achieve the same interest saving benefits as an offset account.

A redraw facility merely allows you to take these funds back out (either electronically or going into a branch).

3) What is a Line of Credit (all in one facility)?

A line of Credit (LOC) is basically a giant credit card where you have your pay go into, pay all your bills out of it and often no principle or interest repayment is required providing you do not go over the limit set when the loan was taken out.

Question: So which should I use?

All three of these accounts are designed to permit interest savings and therefore may allow you to pay your home loan off earlier.  However, banks being banks are not letting you do this for free.  An offset account will generally require you to go on a package where you will pay an annual fee of circa $300 - $400 per year.  A LOC will generally have a higher interest rate to begin with while a home loan with redraw will often mean a charge for every time you redraw (unless you are on a package above in which case you are paying the annual fee).

 Which one to use will very much depend on your individual circumstances taking into account the following:

1)      Do you have surplus income or cash to put into an offset account – Eg, if you could not afford to put some extra money into the redraw or offset account then there is no point paying for this feature,

2)      Discipline – if you are not disciplined then you could end up treating your home loan like a credit card and spend all your equity,

3)      Taxation implications – there are significant tax implications with the way the ATO treats offset accounts v a redraw facility v a LOC. These implications apply if you are renting your property out or think you may rent it out sometime in the future.

Need to know more? Australian expats here, Temporary Residents here, Moving to Australia here.