Offset account vs redraw facility – the tax difference.
With most lenders, mortgages come with a redraw facility and a mortgage offset account. They both give the borrower some flexibility in reducing mortgage interest and still gives them access to their own funds. But there can be some confusion when it comes to tax deductions when those funds are used for investment purposes. Let’s take a closer look at the differences.
With a redraw facility you can make additional payments to reduce the outstanding balance of your mortgage, which in turn reduces the amount of interest you pay. However, those additional repayments are not locked away – you can redraw on them at some point in the future. This increases the loan balance, so you’ll pay more interest when you draw them down at that time.
An offset account works more like your day-to-day bank account. However, the balance of the offset account is subtracted from the outstanding balance of your mortgage, and you only pay interest on this difference.
So which is the better way to manage your mortgage and minimise interest payments: redraw or offset?
For many homeowners it won’t make too much of a difference. The offset account is a bit more convenient as all your cash is working to reduce the outstanding loan amount on which interest is calculated.
The redraw facility may require a bit more active decision making regarding how much to pay off or redraw and when. Some banks also set minimum redraw amounts or may charge fees on each withdrawal. On the plus side, the extra effort involved with a redraw facility can provide an element of discipline for people tempted to dip a bit too readily into the available funds in the offset account.
This is where it can get tricky. If you’re borrowing to invest, choosing between redraw and offset can have a significant impact on your tax bill.
Imagine you buy an investment property and have a loan of $500,000. The interest on this loan is tax deductible. Let’s say you then receive a windfall, like an inheritance, that allows you to pay off $100,000, leaving a loan balance of $400,000. Soon afterwards you redraw $50,000 to splurge on a holiday or new car. The loan now jumps to $450,000, but as the new redraw is for personal use the loan amount associated with the investment property remains at $400,000. You won’t be able to claim a tax deduction for the interest on this $50,000 redraw. What you will likely end up with is a headache from trying to manage the personal and investment components of the loan as future repayments or redraws are made. The investment purpose of the redraw needs to be kept pure.
Now imagine that you deposited your extra $100,000 into your offset account. The bank subtracts this from your loan balance of $500,000 and only charges you interest on the $400,000 difference. The crucial difference is the loan amount is still $500,000 and it’s all associated with the investment property. The withdrawal of $50,000 from your offset account is unrelated to the investment arrangement – so it doesn’t confuse things. Yes, you’ll pay interest on the full loan amount of $450,000, but it will remain fully tax-deductible.
Even if you are not a current investor but there’s a chance your existing home may turn into a future investment property, the same principles above will apply.
I think the offset account wins - provided you have the discipline to manage it. The offset account can provide more flexibility than the redraw facility and could save you costly tax issues. But to be certain about what suits you best, always seek professional advice.
Shaun O'Keefe helps families feel more financially secure. He's found that he can help more people, more effectively when he helps families. As a fee-based financial planner, he works with families just like yours to bring personal values and financial resources in line so that you can keep focussed on the priorities in your life.
The information contained in this article is general in nature only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision concerning a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.