Offset vs redraw - have you got it right?

In a world of rising interest rates, an offset account or redraw can help you to reduce the interest charged to your loan each month. As rates and repayments increase, many people however do not understand how to use an offset or redraw to their advantage; nor which option they should use.

To put it simply, an offset account is an actual transaction account, with it's own BSB and Account Number, which sits alongside your loan. When the bank charges interest on your loan once a month, they deduct the balance of your offset account from your home loan balance and then only charge interest on the difference. Therefore, the more money you have sitting in your offset account, the less interest you will pay in the month and over the life of your loan.

Redraw funds (or a redraw facility) serves the same purpose in reducing the interest charged each month on your home loan. However, instead of your available money sitting in a seperate offset account, your funds sit directly in the home loan itself. Again the bank will reduce your home loan balance by your redraw funds and only charge interest on the difference.

So understanding these differences in how an offset and redraw work, which should you use?

The correct answer depends on your personal situation. With an offset account, you can have your pay credited to your account, accumulate any savings you have in the offset and transact on the account by way of BPAY or via an ATM. This account becomes your hub; your everyday account. Then as interest is calculated daily but charged once a month, the more money you have going into your offset over the course of the month, the better.

Redraw on the other hand only applies when you either transfer money into the loan account itself from a seperate bank account or you pay more than your set repayments, thereby accumulating surplus money in your home loan which can then be redrawn. Unlike the offset account, you cannot have your pay credited to the home loan or transact on your home loan as per an everyday account.

So which is right for you? An offset account costs either a monthly or annual fee. To make an offset worthwhile, you want to have money sitting in your offset account over the course of the month to reduce your interest. Sure, it can come in and out, but you want the overall effect to be that there are funds accumulating in this account over the month.. By having wages credited to your offset and transferring all your savings here, you will maximise the benefit of the offset and make the offset account fee worthwhile.

If this is not you, rather after you have been paid and cleared all your bills, you are someone who has little by way of surplus funds left over, you may be more suited to utilising your redraw facility on your loan. If you still want to attempt to reduce your interest in the month, you can transfer any accumulated savings over time into the loan itself (even if you build these up slowly).. You can also elect to pay higher than the set repayment (assuming it is affordable) to gradually build up redraw funds.

Either way, using an offset or building up redraw funds will help to reduce the amount of interest charged to your loan in the month. The more you can accumulate in the loan itself as redraw funds or in the offset account alongside your loan, the better.