An offset account and a redraw facility are common features for Australian home loans and mortgages, however many Australian residents and expats don’t fully understand the differences between the two and the tax consequences that can be created by using them incorrectly.

This week our team at Loansuite is exploring the key differences between an Offset Account and a Redraw Facility, the pros and cons of each option, as well as some key case studies to outline the power of each option.

Let’s start with the basics.

What is an Offset Account?

An offset account is a separate bank account that you can use as an everyday deposit and transaction account in most instances. It allows you to have your salary or rental income paid into it for example, and you can pay your bills and other expenses from the account. The offset account is linked to your loan account, which is saving you interest on a regular basis, often calculated on a daily frequency.

For example, let’s assume that Bob has a current variable rate mortgage of $500,000. Bob decides that he’s going to have his salary paid into his offset account, which is linked to his $500,000 mortgage, and he’s managed to accumulate $50,000 in his offset account. This means that as Bob’s interest payment is calculated for each of his regular mortgage repayments, he will only be paying interest on $450,000. This is worked out by deducting the offset account balance ($50,000) from the mortgage balance ($500,000).

The offset account can be a great place for many Australian expats and residents to keep their emergency fund, as it is typically going to be ‘earning’ a greater interest rate than savings in an ordinary bank account or term deposit. Be sure to check that your offset account has its interest calculated daily, and you can have multiple salaries and other income streams paid into it to ensure that you can maximise the benefits of the account.

What is a Redraw facility?

Unlike the offset account, the redraw facility is simply a feature of the loan itself, that allows you to make additional repayments to your loan account, above and beyond the minimum required amount, which are pooled in the loan account and you can withdraw these at any time should you need to.

For example, let’s assume the same example as above. Bob has a current mortgage balance of $500,000, and instead of using his offset account, Bob decides that he’s going to make an additional repayment of $50,000 into his loan account, resulting in the loan balance of $450,000, and $50,000 being made available via his redraw facility. Bob can now speak to his bank or mortgage broker and consider adjusting his regular repayment amount based on the new mortgage balance.

You might be thinking, ‘what’s the difference between the two given that Bob still has an outstanding mortgage balance of $450,000’, and the answer lies largely in the tax treatment of the future use of these funds.

Let’s consider which is most suitable for you.

Is the Redraw facility or Offset account better?

Both are common features of Australian loans and mortgages, and both allow you to reduce the amount of interest that you’ll need to pay, and while there is no one-size-fits-all answer to which is best, in most cases we find that the Offset account is a more suitable option for most.

The key benefits of the Offset Account are as follows:

• Access to Funds: The offset account is just like any other bank account, and you can access them with an ATM card or via your online banking instantly. Redraw facilities however could take time or incur fees with some lenders to access.
• Timing: Having salaries and other income streams paid into your offset account could allow you to save a small amount of interest before those funds are withdrawn for expenses such as utility bills or groceries. In most cases, you’re not going to transfer a small amount into your loan account and then redraw it just days or weeks later given the administrative hassle of doing so.
• Tax Treatment: This is the key reason for many that the offset account often is a clear winner when comparing the two. By holding funds in the offset account, which might be reducing the amount of interest your pay on your home loan or investment property loan, you’re not altering the purpose of the original loan at all, which is particularly important if it’s an investment property.

Let’s consider an example

Our friend, Bob, still has his mortgage of $500,000, and $50,000 in cash that he’s trying to decide what to do with, put it in his offset account, or pay it into his loan account given that he has the redraw facility set up already. To add further context, Bob is an Australian expat living and working in Hong Kong, and the property is an investment property. Let’s consider his options.

Option 1: Redraw Facility

Bob decides to pay down his loan balance with the $50,000, which means that his loan balance is $450,000. This reduces Bob’s ability to negatively gear, but this is not of any major concern to him. Two years late, Bob decides to repatriate to Australia and he’s looking to buy his own home as he wants to keep the investment property as an investment. Bob needs to access the cash via his redraw facility to put towards the deposit on buying his own home. Bob has now effectively changed the purpose of that $50,000 into a non-deductible loan as he’s using it to buy his own home. This could effectively mean that Bob can now only claim interest on $450,000 and not the full $500,000, despite the fact that the loan balance secured by the investment property is now $500,000. This is not a great outcome tax-wise, and also creates the added administrative burden for Bob of having to split the deductible and non-deductible interest when completing his tax return.

Option 2: Offset Account

Instead, Bob seeks advice, and decides to utilise his offset account for the $50,000. Bob is now paying interest on the $450,000 just as he was in the first example. Bob returns to Australia, withdraws the $50,000 from his offset account to put towards the deposit on his new home, and can still claim the interest expense on the full $500,000 as he has not withdrawn anything from the loan account or changed the purpose of any of the debt.

The power of the offset account relative to the redraw facility should now be quite clear to you. If you’re an Australian expat or resident, and you’re considering your options when it comes to how to structure your loans, reach out to our team for an obligation-free chat to see how we can assist.

Ally Home Loans Pty Ltd is your ally in finance for all of your home loan, investment property, business and commercial financing needs. With our wide range of lending solutions, expertise in financial planning and investment strategies, and extensive experience in working with both Australian residents and Australian expats, we are your partners for your lending needs.

Book an obligation-free, complimentary consultation here today.

Ally Home Loans Pty Ltd is an Authorised Credit Representative (Credit Representative Number – 494608) of My Local Broker (Australian Credit License – 481374). Important Disclaimer: Your complete financial situation will need to be assessed before acceptance of any proposal or product.