Offset or Redraw Facility, The Smart Option

The reality is, most of today’s borrowers will ask for a redraw or offset facility with their home loan even if they don’t understand how the benefit is applied. Most lenders have either an Offset or Redraw facility as an option with their home loan products and the best ones offer both. 

Some lenders charge a fee to maintain an offset account and some lenders have restrictions on the minimum amount of money you can redraw from your home loan or charge a fee each time you need to access funds. 

Let’s look at simplified versions of how these two facilities work and how the benefit is applied to your home in each instance. Note, a redraw facility sits within a home loan whereas the offset account is a linked external account. 

Redraw

In order to accumulate a balance in their redraw facility, the borrower needs to deposit funds additional to the required repayment amount for their home loan, this leads to their home loan becoming ‘in-advance’. The borrow will need to either get online or contact their bank whenever they want to access the funds paid in-advance. The funds will need to be transferred into their savings account which gives them access options. 

Example

You purchase an investment property for $500,000 and borrow $500,000 interest only. Over the course of 5 years, you make additional repayments of $50,000 so that the loan balance is now $450,000. You decide to redraw the $50,000 equity and buy a boat. The loan now is only 90% deductible and 10% non-deductible, as $50,000 of the loan balance was used for a non-deductible purpose. 

Offset

In the offset scenario, only the required repayment amount is paid into the home loan and the remaining funds are held in their offset account. 

For home loan and savings accounts, interest is calculated daily however declared monthly in the account. Be it the Offset or Redraw facility option let’s assume (Z) is the interest applied, the benefit equation can be stated as: Z = X – Y 

Now, let’s look at what the benefits these two options offers. As benefits revolve about taxation, Ian Wood of Value Beyond explains below the advantage of having an offset account over an redraw facility. 

The ATO’s approach to deductibility of interest is to look at the purpose for which the money was borrowed. If you take out a loan for an investment property or for shares that earn income, then the interest is deductible. However, this general rule will change when the loan is paid down, and then money is borrowed back out of the loan for a new purpose. If the additional borrowing back out of the loan is not used for a deductible purpose e.g. bat, holiday, new car etc. then not all of the interest will be deductible because it is no longer the case that all of the borrowed money was used for a deductible purpose. 

Having an offset account is a different situation. When you pull money out of an offset account, the original loan amount has not changed, and therefore the deductibility of the interest on that loan will not change either. The offset is a transaction account, so when you draw money out of the offset account it is not coming out the loan account, so the purpose of the loan hasn’t changed.

Example

You purchase an investment property for $500,000 and borrow $500,000 interest only. Over the course of 5 years, you save 50,000 in an offset account. The actual balance of the loan is still $500,000, however the net balance of the loan for interest calculation is $450,000 ($500,000 -$50,000). You decide to redraw the $50,000 equity and buy a boat. The interest on the $500,000 loan is still 100% deductible as that money has only been used to purchase the investment property. The cash used from the offset to buy the boat, has not changed the purpose of the loan at all, and therefore doesn’t affect the deductibility of the loan account. 

Your Options

From the above examples, you can see that having an offset account gives you a distinct advantage when it’s linked to your investment loan. There is advantage in having an offset account against your owner occupier home loan as well if you intend to upgrade to a new home and convert the existing to an investment loan sometime in the future as it will allow you to reduce the interest applicable on your loan without reducing the balance while it’s classed as owner occupier loan. 

When it comes to getting value out of your loan structure and to ensure that you are awarded quality direction, an experienced lender is irreplaceable. And if you are paying to use your redraw facility or an offset account fee with your bank, I suggest moving to one that gives you better value. 

https://www.ato.gov.au/Individuals/Income-and-deductions/Deductions-you-can-claim/ 

Ian Wood is a CA and aside from being director of Value Beyond Pty Ltd, he is an author and regular ABC radio contributor on all things Tax.