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 can involve an account fee, a package fee, or a rate higher than the same lender's loan without one. Whether the interest reduction exceeds these costs depends on the fees, loan rate and balance held.
• 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.
• Offset funds are generally accessed through the linked transaction account, while redraw availability, timing, limits and fees depend on the loan contract.
• Money held in an offset reduces interest at the home loan rate. Other debts may have different rates, fees and repayment terms, so the outcomes are not directly interchangeable.

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 can also involve an account fee, a package fee, or a rate above the same lender's loan without the feature. On the example above, an annual package fee of a few hundred dollars would reduce the illustrative $1,200 interest saving. Against a balance of $2,000, which would reduce interest by about $120 a year at the same rate, those costs could exceed the interest reduction. The result depends on the product terms, loan rate, fees and balance held.

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.

How access differs for an emergency buffer

Offset funds are generally accessed through the linked transaction account. Redraw availability, timing, limits and fees depend on the loan contract. Other factors include offset or package fees, lender terms and tax treatment. A lender, broker, accountant or suitably qualified adviser can help assess how these factors apply to a person's circumstances.

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 above your home loan rate, money in an offset reduces interest at the home loan rate, not the other debt's rate. On $5,000 at 6.00% that's about $300 a year, while $5,000 of credit card debt at around 20% incurs about $1,000 a year in interest (both illustrative). Fees, repayment terms and the person's circumstances also affect any comparison.

Compared with a separate savings account, the result depends on the home loan rate, savings rate, fees, tax treatment and balance held. Using the illustrative rates above, $2,000 in an offset at 6.00% compared with a savings account paying 4.75% produces a difference of about $25 a year before fees and tax. Access and account-separation preferences also differ.

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: When eligible accounts are connected, WeMoney can help you view balances and transaction activity in one place.

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.