GENERAL ADVICE WARNING – Please be mindful that the information contained in this post is general in nature. You should seek advice that takes into account your specific circumstances before embarking on any significant financial matter.
Should I be putting my savings in an offset account, or paying it straight off the loan and accessing via a redraw if I need it? This is a question I get asked pretty regularly, so perhaps it’s on your mind too.
Let’s start by explaining the scenario here so that everyone’s on the same page. Assume you received a $20,000 bonus from work. You have a mortgage against your home, and have no immediate spending needs for this money. You could pay this $20,000 off your home loan. In doing so, assuming the loan allows it which most do, this $20,000 would then become available as an amount that could be redrawn. This is money you’ve put into your loan over and above the required loan repayments, so you are ahead on your loan, and the bank will then let you pull that back out again in the future were you to ever need it.
The alternative is that you have a separate Offset Account which is linked to your home loan. Any money deposited into this offset account is netted off against your home loan and the interest that is applied to your home loan is commensurately reduced. The offset account in isolation has no interest earnings. The effective earnings from the offset account comes through from savings within your home loan. Effectively it means that more of each of your regular repayments is coming off the principle and less to the interest.
The crucial thing to be aware here is that mathematically these two options are identical. Whether you pay your $20,000 off the loan, or sit it in an offset account, the interest saving on your loan is the same.
I should point out here that for simplicity in this case I’ve referred to a single lump sum. But quite possibly your redraw capacity or offset account might be built up through regular monthly contributions, perhaps paying more than the minimum off your loan, or deliberate additional deposits.
The fact that these two approaches deliver the same outcome with regards your loan is why this question of offset versus redraw comes up. If they are mathematically the same, how do you choose?
Which way to go?
In most cases, using an offset account in preference to redraw is considered the best option. The main reason involves the scenario where at some point in the future your current home becomes a rental property. Perhaps you move interstate or retire down to the beach, who’s to know? But the change from the property being a primary residence to it becoming an investment that generates income has significant tax implications.
With the property now generating taxable income, any expenses would be tax deductible. That includes interest expenses on the loan. If you’ve been building up your savings in an offset account, then withdrawing these to use to purchase your new home causes no difficulty. The loan that sits against your previous home is unimpacted and the interest costs can be deducted from the income that the property generates.
But if you’ve been building your savings up in redraw, just paying it off the mortgage, the outcome is not nearly as good. Certainly you could access your savings in exactly the same way that you could access money you had in your offset account. However because the purpose that you are putting this money to is to buy a new principle place of residence, and that is not an asset that will generate taxable income, then the effective increase in the debt on your previous home ceases being tax deductible.
Let’s go to some numbers to help this make sense.
Say you have an $800,000 mortgage. Over the past decade you’ve built up $300,000 of savings. You now want to move closer to the beach however you plan to keep your current home as a rental property. To enable you to purchase the new home you want to use those $300,000 of savings for the deposit.
If you had built these savings up in an offset account, no problem, simply use the funds and the $800,000 mortgage against your previous home will be tax deductible provided the old property generates taxable income.
However had you instead paid that $300,000 directly off the home loan, when you redraw that, the tax deductible portion will now only be $500,000. The extra $300,000 of debt will no longer be tax deductible because the tax office would consider that the purpose that these newly borrowed monies have been put is into an asset that does not generate taxable income and therefore any expense related to that debt is not tax deductible.
Now as I said at the beginning, mathematically when you’re depositing your savings and sitting them either in an offset account or directly within the mortgage and having it available as redraw, it is the same result. And for most people, their current home will never become a rental property. But given there is no penalty for using the offset account, why wouldn’t you at least have that option available to you?
A secondary lesser reason why you may prefer to use an offset rather than a redraw arrangement is that for some loans there is a minimum permitted redraw amount. It might be $1,000 or $5,000 for instance. This introduces inflexibility into the equation. What if you only wanted to get $500 out? You don’t have this inflexibility with an offset account.
So can we say that all savings should go to an offset account in preference to simply paying them off your mortgage and having them available via redraw? Well not quite. Often the lowest cost loans don’t have offset account facilities. They are typically very stripped down products with minimal bells and whistles. It could therefore be that taking out a home loan that offers an offset account is costing you more money relative to one that does not. These very bare bones basic home loans typically have other drawbacks beyond the lack of an offset account such that the availability of an offset account alone may not be the sole reason to go for a more fully featured loan product, but certainly as the borrower you would want to do your numbers and check this. The more fully featured loans could have a higher interest rate, a higher monthly fee, or both.
Before we wind this one up, we should just step back a moment and consider whether an offset account or redraw capacity makes sense for your savings in the first place.
These are a great place to house savings where you require liquidity and accessability. For longer term savings however it is likely that investing in growth assets such as shares and property will deliver a better outcome. This is especially the case whilst interest rates are low. If you have significant savings built up and sitting against your mortgage, consider how that aligns with your long-term goals and whether you are putting these to their best possible use.
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