Many people with a home loan use a redraw feature where they know they have access to extra money they have paid off their loan over and above the minimum repayments required. Borrowers find they accumulate advance repayments over time, whether through keeping their repayments at the same level as interest rates have fallen, or as some do, having all their surplus income/savings channelled to the loan and parked there until needed.
Almost all variable rate loans offer a Redraw or Cashback feature, which makes withdrawing the advance money paid off the loan quite quick and convenient. Some loan products do have restrictions, such as minimum redraw limits, or a fee for the transaction.
Whilst most borrowers using this feature are well aware of the advantages in paying extra off their loans, this article is not about highlighting the benefits of redraw, but rather to the contrary. I’m quite certain that many are not aware of two considerable risks associated with using redraw, which are:
Lenders can suspend or cancel your right to redraw at any time.
This sounds a little scary doesn’t it! Knowing the banks have the power over you. To quote just one of the major bank’s policy on this, the terms and conditions read, “We can suspend or cancel your right to redraw at any time if we reasonably believe there is a valid and sufficient reason, which is either in your or our interest, to do so”.
I’m sure you would not be happy if you went to withdraw your ‘savings’ you have ‘put off your loan’ and your request was denied. However I must admit, the likelihood of lenders saying no to this is very remote. In my 20+ years dealing with home loans I can never recall anyone being refused to redraw (in the absence of any extenuating circumstances). The most likely situation where the lender may say no is where the security they hold is not sufficient to support your obligations under the contract, or you are in default of the loan contract in some other respect.
I’m personally not too concerned about this, and will still be recommending clients take advantage of this great loan feature that helps them save interest on their loans. I just wanted to alert you to the fact that these policies exist, and to never assume that you always have total control over your advance repayments. Banks really do like to be the ones in control in all areas of your mortgage, and if you actually took the time to read through every word of their loan terms and conditions, and you wanted to play it safe, then you probably wouldn’t be borrowing from them in the first instance.
Money you have accumulated off your loan available for redraw is not savings.
Yes, most borrowers consider the extra money they put off their loan as being their savings for future access and use. And why shouldn’t they, given how easy it is to put there, and the banks promoting their redraw features where you can so easily withdraw it back when you need it. However it’s the Australian Taxation Office that tells us that money accumulated in advance repayment is not savings.
The ATO state that “where a loan facility allows for redraws of extra repayments, we consider those redraws constitute new borrowings of funds that cannot be traced to the extra repayments. In this regard the term ‘redraw’ is a misnomer. It is in effect a new borrowing of funds”.
So the money you have ‘parked in your loan’ which may be available for redraw is therefore not an asset of yours.
In the normal course this is not really an issue. But when it does become a big issue is if you want to vacate your home and lease it to a tenant. When your home becomes a rental property, you are only permitted to claim deductibility of interest expense on what your loan balance is, prior to any redrawing of extra repayments.
So if you want to redraw any money to help you buy another home to live in, well I’m sorry to inform you that any money you redraw back from your loan is not going to be tax deductible. As the ATO views any redraw as a new borrowing, the deductibility of interest payable on those new borrowings depends upon the advantages sought from the use of those funds.
This is a common situation I come across with clients almost every week. They’ve worked hard to pay the extra off their loan, however when it comes to wanting to lease out the home, grabbing the extra cash back for their next home leaves the gearing structure less than ideal.
I’m not suggesting here that you don’t pay extra off your loan. I simply want to make you aware of some pitfalls to be wary of. If there’s a possibility that you may one day lease your home, then an Off-Set account alongside your home loan is one of the best ways to overcome this ATO ruling.
Discussing your future plans with an experienced mortgage adviser and in conjunction with your accountant and/or financial planner could prove invaluable for you in the long term. If you’d like some smart mortgage advice about your situation and future plans I’d love to hear from you.
Cairns Mortgage Broker – Jason Thomson is a Mortgage Adviser and Finance Broker based in Cairns with clients all around Australia. Client reviews featured on his website prove that Jason is a trusted industry professional, facilitating great outcomes for his clients. Using his wealth of experience in financial services, he thrives on delivering superior service. Jason is very approachable and is always looking for new clients to help in the often confusing world of finance and property. Offering a no fee service, you’ve got nothing to lose by having an obligation free chat with Jason today.