Probably one of the most talked about topics at a client meeting would be the differences between having an offset account, or a redraw facility. Thus, I thought I would briefly touch on this as no doubt there would be a few people searching the net for answers.
An offset account is essentially a banking transaction account. This account is linked to a person’s mortgage, and any balance that sits in that account “offsets” the balance of the mortgage. To give an example, let’s say that you have a mortgage with a current balance of $500000.00. In your offset account you have a savings balance of $200000.00. What this effectively means is that you will be charged interest on your loan, as if the balance of the loan is $300000.00 and not on the full $500000.00 that you actually owe. In this way offset accounts are a brilliant way to save yourself a lot of interest charged over the life of a loan, if used effectively.
Similarly, a Mortgage that has a redraw facility can also be an effective way to try and minimise your interest paid out over the loan term. Normally a redraw facility is used in conjunction with a variable loan, but you can get a redraw on a fixed loan facility too. Again, let say you have a $500000.00 loan balance and your loan repayment on that was $2000.00 per month, you then go and pay $3000.00 into the loan for that month. You now have paid your loan for the month plus an extra $1000.00 that now will be showing on your account as extra, with a redraw you will be able to redraw that $1000.00 if you needed it for something else. The $1000.00 extra that you paid has reduced your loan by that much and you are now saving on the interest you would have paid on that $1000.00 that you would have loaned. Again this has a compounding effect on the interest you would save if you were to keep up with the extra repayments into the loan, and at the same time you would be building up a savings account, that is working against the interest of your loan.
The two types of facilities (offset, redraw) have a few pros and cons when it comes to what and how they are used.
Accessibility and Ownership. With an offset account the funds in that account are yours, from an ownership perspective, and you can use them and move them wherever you like for other things. Extracting your money out of an offset account will also not cost you anything. With a redraw facility when you put extra funds into the loan, those funds become a part of the loan funds. If you want the extra funds back you effectively have to “ask’ the bank for them back, and although there are a lot of loan accounts with a free redraw facility, some banks will still also charge you a fee for redrawing funds. Another factor to consider with a redraw facility is that the extra money that you have put in there may be whittled down a little by interest charges or the like being taken out of them. So at last check you may have had $5000.00 extra in the account that you were banking on, but after the last payment $5 interest was taken out of that so its not all there, and as I say you were banking on it.
Effectiveness. I say this purely for those clients that are really focused on trying to pay there loan off as quickly as possible. In this regard I find an offset account to work best. With an offset account you can have every dollar that you own working against the loan. How? You say. A loans interest charge is calculated daily and then charged either at the end of the month or as per your elected payment cycle. So, if a family were to have both applicant salaries paid at the beginning of the month into their offset account it would be the same as having paid the loan off by that amount. As the family pay there monthly bills from that account the “extra “they have paid will decrease. However every day that those salaries are in there , they are working against the interest of the loan. This means that you can basically use every dollar that you earn to work against the interest incurred by your loan if structured correctly. With regards to a redraw you really should only be putting extra money in that you may not need immediately due to accessibility constraints as mentioned before. Meaning that an offset account can be considerably more effective in this regard.
Cost. What you do find in looking at these two facilities is that they also vary in cost. While there are a few banks that will do a free offset account, most include them in a package which comes with an annual fee that can vary from anywhere between $250-$400 per annum. While this may not seem like a lot on a smaller loan size say of $100000.00 this would be like adding 25 to 40 basis points on to the interest rate. Most basic “no-frills” variable loans come with no account keeping fee’s making them cheap to run and normally have a good Comparison rate. They will however normally have a once off establishment fee. Determining which in this instance will suit clients is usually a little more tricky, and here it would be wise to consult with a good mortgage broker to see what will suit your individual circumstances.
I hope this has un-muddied the water a little bit and given a little more clarity into how an offset account works, as well as how a loan that has a redraw facility works. I would always recommend you have a chat with a mortgage broker, or lender to clarify any questions you have and make sure the product you chose is suited to your situation. If you are looking for a Mortgage Broker in Adelaide, please do not hesitate to get in touch with us.