How offset accounts and redraw actually work

Key points

• An offset account is a transaction account linked to a home loan, and its balance is subtracted from the loan balance before interest is worked out each day: $20,000 held against a $500,000 loan at 6.00% (illustrative) means interest is charged on $480,000, which saves roughly $1,200 a year (~$23 a week).
• Offset features often come with an account fee, a package fee, or a rate slightly higher than the same lender's loan without one, so the check worth doing is the fee against the interest you'd actually save on the balance you'd realistically keep there.
• Redraw is the extra repayments you've already made, available to pull back out. It reduces interest the same way, however that money has been paid to the loan, so what you can take back, when, and at what cost all run on the terms of the loan contract.
• For money you might need at short notice, an offset usually suits better than redraw (depending on the fees, and only where you'd genuinely keep the money there).
• While you're carrying credit card or personal loan debt at higher rates, money in an offset is saving you the home loan rate rather than the higher one, so the question worth answering is which debt the money is working against.

An offset account and a redraw facility both park money against a home loan, and both reduce the interest you're charged. However they behave very differently the moment you need that money back. What's in an offset account is still sitting in a transaction account with your name on it. Money you can redraw has already been paid to the loan, and getting it back runs on what your loan contract says. So here we go through what an offset does to the interest, how redraw compares, and how both sit next to keeping a separate buffer.

How does an offset account actually work?

It's a normal transaction account whose balance is subtracted from your loan balance before interest is calculated (each day, so the balance counts for every day it's in there). Your pay can land in it, your bills can come out of it, and it usually comes with a debit card and the transfers you'd expect. The only thing that makes it different is the link to the loan.

Take an example loan of $500,000 at 6.00% (illustrative) with $20,000 sitting in the offset. Interest is charged on $480,000 rather than $500,000. Over a year that's $28,800 instead of $30,000, so the $20,000 saves roughly $1,200, or about $23 a week. Nothing gets paid to you and no interest is earned. The saving shows up as interest you're not charged.

An offset is worked out on your daily balance, so money sitting there for a few days still reduces the interest charged for those days.

That daily part is easy to underrate. A pay that lands on the 1st and gets spent down over the month has still reduced the balance interest was charged on for every one of those days, and the same goes for money sitting there between a bill arriving and the day it gets paid.

Not every offset is a full one. Some accounts offset only part of the balance, so the same $20,000 might reduce the interest-charged balance by less than $20,000, and the product page is where that's set out. Offset features also tend to carry a cost: an account fee, a package fee, or a rate slightly above the same lender's loan without the feature. So the useful check is the fee against the saving. On the example above, an annual package fee of a few hundred dollars still leaves you well ahead of $1,200, however against a balance of $2,000 (which saves about $120 a year at the same rate) it wouldn't, so run that check on the balance you'd realistically keep in there rather than the one you'd like to.

Redraw: the same saving, a different kind of access

Redraw is the extra repayments you've already made, available to pull back out. If your minimum repayment is $3,000 a month and you've been paying $3,500, that extra $500 a month has gone onto the loan, and on most variable loans it's available to redraw later.

It reduces your interest in the same way an offset does, because a smaller loan balance is a smaller balance to charge interest on. The difference is what happened to the money. It has been paid to the loan, so it's no longer sitting in an account you control, and what you can take back out is governed by the loan contract.

In practice that can mean a minimum redraw amount, a limit on how much or how often, a fee for each redraw, and a wait of anywhere from the same day to several days before the money reaches an account you can spend from. How much is available to redraw is also set under the loan contract and can be varied or paused, so it's worth reading what your contract says about it rather than treating the figure in your banking app as fixed. Fixed-rate loans commonly cap extra repayments as well, which caps what there is to redraw in the first place.

Below is the comparison in one place (general mechanics, and the detail varies by loan).

The two are also treated differently for tax on an investment-property loan, and that one is for your accountant or a qualified adviser rather than for a general article.

Which one suits an emergency buffer?

For money you might need at short notice, an offset usually suits better (depending on the fees, and only where you'd genuinely keep the money there). Both reduce the interest you're charged by the same arithmetic, so what matters here is how quickly you can get at the money. Offset money is in a transaction account you can use immediately. Redraw money has to come back out of the loan on the lender's timing and terms, and an emergency is exactly the moment that difference shows up.

How much to hold, and how to build it while you're paying down other debts, is its own question, and we've gone through it in our guide to building an emergency buffer while paying off debt, including why the first few hundred dollars do most of the protective work.

If you're also carrying credit card or personal loan debt at rates well above your home loan rate, money in an offset is saving you the home loan rate, not the higher one. On $5,000 at 6.00% that's about $300 a year, while the same $5,000 against a credit card at around 20% would avoid about $1,000 (both illustrative). So the question worth answering at that point is which debt the money is working against.

Against a separate savings account, an offset generally saves you more on the same money, because home loan rates are usually higher than the rate a savings account pays. On a starter buffer the gap is small though: $2,000 in an offset at 6.00% against a savings account paying 4.75% (both illustrative) works out at about $25 a year of difference. Some people keep the buffer in a separate account for exactly that reason, and that's completely fine, because an offset that doubles as the everyday account is easy to spend down without noticing.

Where this stops being general information

Structuring a home loan around an offset or redraw is a decision to take with your lender, your broker or a qualified adviser. Whether to split the loan, how much to keep where, and whether an offset is worth its fee on your particular loan all depend on what your loan contract says and on your own circumstances. The same goes for the tax treatment of offset and redraw on an investment-property loan, which turns on facts specific to you and belongs with your accountant.

This page covers the mechanics to understand before you have that conversation.

Whichever way you end up going, the starting point is the same: what your loan is charging, what's actually in the offset, what's actually available to redraw, and what your other debts are costing you over the same period.

Pro tip: Once your accounts are connected in WeMoney, the home loan, the offset and your other debts all sit in one place – so you can see which balance your money is actually working against before you decide where the next spare $1,000 goes.

Sources

• Moneysmart: Home loans
• Moneysmart: Mortgage offset accounts
• Moneysmart: Pay off your mortgage faster
• Moneysmart: Mortgage calculator

This article provides general information only. It does not take your personal circumstances into account and is not financial, credit or legal advice. Consider your own situation and seek advice from a suitably qualified professional if you need it.