Shaun Farrugia recently created this video to explain a question that was on a few of our clients lips.
Watch below to hear the difference between an offset and a redraw account on your home loan. This is a question we do get very often, so we’re hoping this will be of value to you.
First of all, why would you use either a redraw or an offset account?
Both of these accounts allow you to make extra repayments on your loan, and then to pull them out afterwards. Not all loans do have a redraw facility, or an offset account. Some do, and there may be charges that apply to it, that’s something that is on a case by case basis that we would discuss later on.
Secondly, what is the difference, and why would you potentially use one over another?
It’s an ability to make extra repayments into your loan that then reduce the loan balance. So, for example, you have a loan of $400,000, and then you make a deposit of $10,000. This is an additional repayment that was (maybe) a lump sum that you received, then you’ve got a loan balance of $390,000. This is the amount that the bank would charge you interest on.
So, on a rate of say, 4% per year, you would save $400 in interest every single year by having that $10,000 parked into the loan. Now, the redraw facility allows you to then pull that money back out. Instead of the loan going from $390,000, you can then do a debit of your $10,000, so we then will have a debit. So $10,000, this might be for a holiday or to pay for school fees or a car repair, something like that. Your loan then goes back up to the $400,000. So as the repayments go in and out, the loan balance changes and fluctuates.
Now, this can be really good as a bit of a motivator because you can see your loan balance go down over time, so it’s motivating, and I guess encourages you to put more money in. Where the downside is, is if you ever wanted to make your property an investment property down the track, the tax implications can be fairly severe. The reason why they are severe is because the loan balance is going back up, to the ATO, it’s considered new borrowing.
So if you borrowed, or if you’ve done a redraw for a holiday, that would be considered private, and a then a portion of your loan balance forever, (for basically the life of the property) would be non-tax deductible. However, it was for say, buying of dividend shares, maybe Telstra or BHP, then yes, you would still retain tax deductibility.
The takeaway with this is, is that if you are making a redraw on your loan account, and taking the funds back out, it’s the purpose of what you use those funds for which will determine the tax deductibility. This does get a little bit hairy and a bit in depth, and it’s something I would encourage everyone to get professional advice for, if they are intending to use their property as an investment property in the future.
Now, an offset on another term is basically a savings account.
So, like any normal high interest savings account, you’ve got that sitting there. So, in this kind of scenario, you’d still have your loan, so we’d have the loan here of say, $400,000, and then we’ll have an offset account, and we put $10,000 in.
Now, think of the offset account as your everyday savings account that you’ve got. However, instead of getting charged 4% interest and getting $400 a year in interest on that $10,000 and then having to pay potentially $180 of tax on that $400, the earnings are basically tax free, and that’s because it’s deemed that you’re not actually receiving interest, but what you’re doing is actually paying less interest to the bank.
The way that this works is when the bank have a look at your loan, they’ll see your $400,000 that you owe them, they will see the $10,000 they owe you, and the nice guys that we’ve got at the bank will say, ‘Okay, $390,000 is the net balance that is owed’, and then they’ll charge you interest accordingly on that figure. This gives you a separate account, allows you to make the interest saving without any tax implications, but more importantly, it does preserve the loan balance.
So, what this means is that year, after year, after year, you can keep making any additional repayments into your offset account. This will save you interest in the long run, but then, if you decide to rent your property out in the future, you can pull all that money out that you’ve had in offset over the years, use that as a deposit on your new primary residence, or a holiday home, or anything else, and then that will allow you to reduce your non-tax deductible debt on the private debt that you’ve got there, but then you’re retaining a lovely $400,000 – the whole debt level of the purchase of your first property, and that will then give you a lot of tax advantages going forward.
A Redraw and an Offset are very similar in the way that they help you save money, and they also reduce the loan term by allowing your extra repayments to save interest, but the way that they’re treated from a tax perspective is very, very different.
If you’ve just built your dream house, and you’re pretty sure you’re never, ever going to rent the property out; you’re going to keep it for years, and years, and years, or potentially just going to sell it, but the main crux of it is you’re never going to rent it out, then a simple redraw account is fine, but you are removing any kind of flexibility.
To sum up
- Perhaps right if you are never going to rent out the property
- Extra repayments reduce the loan balance
- Reduces the loan term
- Loan can be slightly cheaper
- Access to funds at all times
- Treated as a savings account
- Extra repayments reduce the interest
- Tax effective if you are going to rent out property in the future
- Reduces the loan term
I hope that this has been helpful. If there are any further questions, feel free to reach out to us, and we’ll be happy to help.
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