With interest rates at historic lows, some homeowners are building up a savings buffer by paying more than the minimum off their mortgage each month.
Evidence bears this out. The Reserve Bank of Australia’s latest Financial Stability Review reveals the balances in mortgage offset accounts and redraw facilities are high, at around 17 per cent of outstanding loan balances.
If you’re thinking about contributing funds to an offset or redraw account, it pays to understand the difference between the two facilities.
Nuts and bolts
A redraw facility allows a mortgagor to reduce their balance and interest payments by making higher-than-the-minimum fortnightly or monthly repayments, or depositing lump sums into their mortgage account.
As the name suggests, these additional funds can be redrawn at a later date.
Variable interest rate loans are typically offered with redraw facilities, although terms and conditions can vary. Some lenders place limits on the size and frequency of redraws, while others may charge fees to deposit and withdraw funds.
It’s a structure that can suit owner-occupiers who are focused on paying down their debt quickly, and don’t require regular or immediate access to their excess funds.
An offset account can also be used to reduce interest payments, but unlike a redraw facility the money deposited into an offset account does not affect the balance of the loan itself.
This is because, under an offset arrangement, the additional funds sit in a savings account that is linked to the mortgage account, rather than in the mortgage account itself.
Instead of attracting interest, the savings balance is ‘offset’ each day against the home loan balance and the interest payable is reduced accordingly.
For example, a mortgagor with a home loan of $400,000 and an offset balance of $25,000 might only pay interest on $375,000.
Lenders offer both 100 per cent and partial offset accounts, and establishment and usage costs can vary.
Individuals who maintain a low offset balance may find the savings it generates are negated by fees, and should be encouraged to do some saving and spending projections before selecting a loan with this facility.
Make sure you talk to your Smartline adviser about all your options before deciding the right path for you.