It’s no secret that the cost of living in Australia is on the up. Thanks to a perfect storm of events, we’re feeling financial pressure at the petrol bowser and in the supermarket (hello lettuce!). With interest rates on the up, our home loans are also adding to the load.
Unluckily for us here in Sydney, that mortgage pressure is the highest in the country. According to the Real Estate Institute of Australia, the average household in New South Wales directs 46.5 per cent of their income towards their mortgage. That’s almost 10 per cent more than the national average(1).
With your home loan taking up such a big chunk of your income, it makes sense to do everything you can to keep the cost down. There are lots of strategies you can use to deal with rising interest rates. But in this article, we are going to zoom in on how you can use offset accounts and redraw facilities to your advantage.
People often get a little muddled when it comes to the difference between offset accounts and redraw facilities. That’s because, ultimately, they work in similar ways. Both allow you to reduce the balance of your home loan by putting your spare cash to work. In return, they both reduce the amount of interest you pay. Deciding between them largely depends on how accessible you need your cash to be.
Redraw facilities allow you to deposit spare income straight into your home loan account. You can then redraw that money in the future if you need it. Whilst your extra money is in the loan account, it lowers the amount of interest charged meaning lower monthly bills.
But there can be restrictions with redraw. It varies from lender to lender, but there may be rules on how much money can be withdrawn and when. There may also be charges involved if you want to get the money back out.
It’s also good to know that most lenders only allow redraw on variable-rate loans (or sometimes limited access on a fixed-rate loan).
Before jumping into redraw as a strategy, it’s important to find out how your lender’s facility works as the fees and restrictions might outweigh the benefits.
Offset accounts are transaction accounts that sit alongside your home loan. The balance of the transaction account (or a portion of it) ‘offsets’ your daily loan balance. The result is that you are only charged interest on the lower loan amount (that is, your loan balance less your offset balance).
Because your home loan interest is calculated daily, every dollar in your offset account can save you money in interest. That means more of your repayment goes towards paying down the principal, helping you to repay your home loan faster.
There are two main types of offset accounts. A 100% offset account means the full balance of your transaction account is used to reduce the interest payable on your mortgage. On the other hand, a partial offset account only offsets your mortgage by a portion of the offset account balance. For example, if you have a 50% offset account, only 50% of the account balance will be used to reduce your loan balance (and hence interest costs).
Whilst there are a few lenders who offer offset accounts on fixed rate loans, they are typically a variable rate loan feature. Offset accounts, like many bank accounts, often come with account fees. It’s important to check the annual fee against your expected interest saving to make sure it’s worthwhile.
Offset account example
Let’s look at an example. If you have a $750,000 home loan with $50,000 in your 100% offset account, you’ll only pay interest on $700,000. That represents a saving of $215 a month or $77,517 over the life of your loan. It also means you’ll cut 1.9 years off your loan term.
If you put $100,000 against the loan, the benefits are even greater. This would deliver you a saving of $396 a month or $142,740 over the life of the loan. And it will cut 3.6 years off the life of the loan.
If you’d like to calculate the impact an offset account could have on your loan, check out this easy-to-use calculator from ING.
Note: Both these examples are based on a 30 year loan term, principal and interest repayments and an interest rate of 3.3%.
1. Real Estate Institute of Australia (REIA) Housing Affordability Report, March Quarter 2022