Two home loan features can save big money but are widely misunderstood

There are two main facilities on a family home loan that should exist in anyone's tax planning toolbox. Unfortunately, they are often misunderstood or improperly used.

Variable home loans are generally more likely to offer features like an offset account or a redraw facility, which are two alternative options that help homeowners reduce their mortgage repayments.

Both tools have contributed to the record rate of debt repayments seen across the country.

Bankwest, for example, said that in March 2022, more than 90 per cent of customers were ahead on their home loan repayments. The average months by which customers were ahead (around three years), increased by 45 per cent.

Their data showed a huge uplift in the volume of savings put into home loan offset accounts. From June 2019 to March 2022, offset account balances grew by 63 per cent – nearly triple the rate of personal savings growth for the period of 23 per cent.

The surge in home loan repayments was matched by a rapid uptake in new home loan offset accounts linked to an eligible home loan, enabling households to use existing savings to reduce their current home loan balance.

Comparison researchers Canstar found that all variable rate home loans and a majority (61.7 per cent) of fixed rate home loans offer a redraw facility.

Canstar analysis of the owner-occupier and investment home loans found that the vast majority of variable rate loans (93.7 per cent) – along with over one-third of fixed rate loans (35 per cent) – offer a full offset account.

So, what exactly are these two, often misunderstood but common, home loan features?

Offset account

This is a standard bank account that is linked to your loan account. The offset account will normally be with the same financial institution as the mortgage provider.

The offset account effectively reduces the loan balance by the amount of money in the offset account, thus reducing the interest component on the monthly loan repayment. This only works with variable rate loans, not fixed rate loans.

This is an ideal location for your emergency cash-float and where your salary or income should be deposited.

The money in an offset account is technically your money, not the bank’s or an early loan repayment. This means that if you take money from the offset account to buy an income producing asset like shares, the interest charged on that purchase cannot be claimed in your tax return.

Purchasing investment assets in this way keeps the loan with its original use, being the family home, not the new asset purchase and the interest not a tax deduction.

So, the main benefit of an offset account compared to an ordinary transaction account is that the money you put into it is ‘offset’ daily against the balance of your home loan, and interest is charged against this reduced amount, rather than the full outstanding balance of your home loan.

Redraw facility

The redraw facility provides the ability to pay down your home loan mortgage in advance and at any time while the loan is active, and then withdraw some or all the amounts paid in advanced.

The act of redrawing alters the usage of the withdrawn amount into a new loan, secured against the family home but assigned to its next use.

If the next use of that money is to generate taxable income, then the interest cost on that new loan (redrawn) amount is tax deductible and ‘good debt’.

If the redrawn amount was used to buy a boat or go on a family holiday, which do not produce taxable income, then the interest cost on this new loan is not tax deductible, and the new loan is considered ‘bad debt’.

The family home, or as we like to refer to it, ‘The Lazy Uncle’, can utilise the redraw facility to maximum advantage.

This works during periods of low interest rates where the cost of borrowing is less than what can be earned by investing in tax advantaged assets, like Australian shares, investment properties or interest-bearing investments, such as fixed interest bonds.

By using the redraw facility and structuring the new loans into sections of variable and multi-year fixed rates for peace of mind and repayment stability, a tax planning strategy starts to emerge where additional cashflow produced can help with:

• accelerated reduction of the family home loan
• additional income to support living expenses
• additional superannuation contributions.

When it comes to funding early, semi or full retirement, using the redraw facility and putting the ‘The Lazy Uncle’ to work is an effective tax planning strategy to consider well in advance of leaving full employment or paying off the family home loan too soon.

Offset account or one-off lump sum repayment into a redraw facility: impact with a $500,000 loan at 3% over 30 years

Source: Canstar. Based on a $500,000 loan with an interest rate of 3%, repaid over 30 years with principal & interest repayments. It is assumed that the offset account balance is kept constant at the specified amount for the entire loan term, or alternatively that the lump sum repayment of the specified amount is made at the start of the loan. Calculations do not take into account any fees that may apply.

Regardless of which strategy is adopted, any extra money paid off on a mortgage or kept in an offset account could save a significant amount in interest in the long run.

But features such as an offset account or redraw facility, as well as refinancing in pursuit of a better deal, can also add costs to a home loan in the form of additional fees or a higher interest rate and may have tax implications, so it’s always worth seeking professional advice to identify the best approach.