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Whether interested in finance or not, we make decisions that impact our financial future on a regular basis. Being informed will empower you to make better decisions, and ultimately lead an easier life.
Buying a home is an exciting time, with many decisions to be made. Signing up for the associated home loan is a necessary evil.
“Even the once simple home mortgage now has so many flavours and styles and variations that it is difficult for people to make a decision”Scotty D Cook
There are over 3000 mortgage products available in Australia. Features, fee structure and eligibility vary between providers. It’s easy to become overwhelmed by the complex options available.
With a series on mortgages, I aim to provide some guidance on the biggest decisions for one of the most significant financial moves you will ever make. Today we look at the mortgage redraw, commonly available with many mortgages.
How does Mortgage Redraw Work?
A mortgage redraw facility is available with many mortgage products. Borrowers may pay extra off their home loan, and “redraw” the extra repayments at a later date if required.
The appeal of a redraw is that borrowers can save money for short-term goals (such as that new car). Borrowers can save ~2.5% in mortgage interest of earning ~1% (pre-tax) interest in a bank account.
Many people use the redraw facility for an emergency fund. They make extra repayments with no intention to withdraw. The extra repayments could be withdrawn to get borrowers through a crisis.
There is definitely a psychological barrier to withdrawing money from your mortgage redraw, so borrowers are not going to accidentally spend this money on discretionary goods and services.
Others will use the redraw facility as insurance against rising interest rates. By making repayments as if the interest rate was 1-2% higher than it currently is, a buffer is built up in the redraw. If interest rates increase, the borrower is already used to the higher payments. If they increase even further, borrowers can use their redraw facility to make up the shortfall.
Fees Charged for a Mortgage Redraw
A basic variable mortgage is generally the cheapest mortgage available (ignoring discount variable loans that offer a seductive “Honeymoon” rate before hiking the rate after 12 months). These generally have no extra features.
A standard variable mortgage or mortgage package will offer more features, but with higher fees.
You will need to decide whether the extra fees are worthwhile in order to use a redraw facility.
Some lenders only charge a fee if the redraw is activated. This may suit those who don’t plan to withdraw, but want to use a redraw as an emergency fund.
Different lenders vary with the flexibility available with their redraw facilities. Some limit the number of redraws per year. Some limit the amount of cash that can be redrawn.
Lenders vary in the ease with which you can redraw cash. With some, it is simply the click of a button to instantly transfer cash from your redraw to your transaction account. Some may find this a little too easy, and want more of a barrier to accessing their emergency fund.
Other lenders require more time to access the redraw. If this is the case, a smaller emergency fund should be kept in your transaction account or credit card.
Can a Mortgage Redraw be Relied Upon?
This is the big issue with redraw accounts.
Once your repayment is submitted, it is up to the lender’s discretion whether they will let you redraw it.
A small proportion of customers have been shocked by the bank limiting the amount of their redraw account when they needed it the most.
It is no doubt bad for the lenders reputation to do this, but they could exercise their discretion should a major economic shock threaten the lenders profitability (or survival).
Commonwealth bank sent a letter to their customers in 2018 stating they had changed their redraw policy. CBA adjusted the amount in redraw accounts to prevent customers redrawing more than they could reasonably repay within the original loan term. This was a minor adjustment.
ME Bank got some bad press for drastically cutting around 4% of their customers redraw balance without notice during the COVID-19 crisis.
Tax Implications of Using a Mortgage Redraw
If you ever converted your home to a rental property, the historical lowest loan balance is the maximum you can apply a tax deduction for interest on.
For example, if your home loan started as $500,000. You are a good saver and pay extra in repayments while you live in the home. Your home loan balance stands at $300,000 when a work opportunity means you move interstate. You decide to keep your original home and rent it out, and purchase a new home near your new place of work. Even if you withdraw your redraw balance (say $100,000), you will only be able to claim a tax deduction on interest for $300,000 of the loan, not the remaining $400,000.
Offset vs Redraw Accounts
Offset accounts are treated the same as transaction account. As long as they are held by an authorised deposit taking institution, the balance up to $250,000 per person is guaranteed.
The money in an offset account also still legally belongs to you, not the lender. The lender has no ability to seize your savings in an offset account in times of financial crisis.
You can also withdraw money from your offset account without any tax implications. In the example above, if the extra $100,000 repayments were kept in an offset instead of a redraw, interest on the full $400,000 loan remaining would be tax deductible should the home ever be converted to an investment property.
The advantage and disadvantage of an offset is the accessibility of this cash. In an emergency, this money can be spent immediately via a debit card, BPay or any other method. Particularly for those with just a single offset, this can be a big disadvantage. Those without great cash flow management can accidentally spend those extra repayments. They can also fall prey to the “Wealth effect” after building up a significant balance in an offset account, there can be a tendency to spend more due to feeling wealthier.
Is a Redraw Worth it?
The savings made by using an offset or redraw depend on the balance you will have in it, and the extra fees paid to have these features. A typical standard variable loan with offset may charge ~$400 per year. If your interest rate is around 3% interest, you would need ~ $10,000 in your offset to make up the fee.
If a mortgage with redraw charges $120 in fees per year, ….maths**
Both a redraw account and offset reduce the amount of interest you pay on your home loan. A redraw can be a good option if you won’t have enough cash to make a standard variable or package mortgage fees worthwhile.
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Aussie Doc Freedom is not a financial adviser and does not offer any advice. Information on this website is purely a description of my experiences and learning. Please check with your independent financial adviser or accountant before making any changes.