Offset and redraw vs savings | Updated: 10:02:06 AM, Monday December 10, 2012
By Bruce Brammall
Don’t be a Gomer Pyle! If you’re serious about saving for your future, and you’ve got a home loan, then offset and redraw accounts are, literally, more than twice as good as savings accounts.
Image: © Lev – Fotolia.com
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What do Bob Hawke, Lance Armstrong and Bill Clinton have in common?
All are very smart people who have said some really dumb things. Remember these classics?
“I have never doped.”
“I did not have sexual relations with that woman.”
“By 1990, no Australian child will be living in poverty.”
On a stupid scale of one to 10, they all rate “Gomer Pyle”. Two of them were outright lies (Lance and Bill). Dudes, there were WITNESSES. And they eventually bleated like sheep.
And then there’s Bob. Bob’s crime was that he didn’t stick to the script. The script said “need”. Bob said “will”. Silly Bobby.
Recently, someone I rate with money smarts said something that was particularly stupid (in my humble opinion).
His line? If you have a mortgage, you should NOT have your “savings” in an offset account. Instead, it should be in a high-interest account.
His reasoning? You’re more likely to spend the money if it’s in an offset account than if its in a separate bank account.
Now, this wise guy’s comment was dumb on two levels.
Firstly, access to your savings. Online banking means high-interest accounts (such as ING Direct, or BankWest) are just as accessible as money in an offset/ redraw account. The difference is a couple of mouse clicks.
Secondly, but far more importantly, you’re ripping yourself off thousands of dollars every year, unnecessarily paying extra tax AND taking longer to own your home.
Offset/redraw accounts are enormously powerful savings tools. They are, without doubt, the best way to save cash for people with mortgages. They deliver returns literally twice as good as earning high interest on your money.
How? Well, let’s have a quick refresher on what offset and redraw accounts are. They are slightly different, but for savings purposes, they provide the same benefits.
Offset/redraw accounts are linked to your home loan. Any cash sitting in the account reduces the amount of interest you pay on your home loan.
Let’s take a home loan of $300,000 and “savings” of $30,000. That is, spare cash that you could use to do anything. But instead of spending it, you’re doing the right thing and saving it.
You could put it in a high-interest online bank account earning interest, or you could use an offset/redraw account.
The high interest account earns 6 per cent a year, or $1800. However, as you’ve earned the interest you must pay tax. The “average” income earner pays 34 per cent income tax is now left with $1188 of the $1800.
Next, let’s put that $30,000 into an offset or redraw account. Mortgage interest rates tend to be higher than savings accounts – the difference is how banks make their money – so let’s use 7 per cent.
If you have $30,000 in your offset, you pay interest for that month on $270,000. You save 7 per cent, or $2100 a year, which comes straight off your home loan. As you didn’t “earn” the money, there’s no tax to pay. Nil. $0.
That’s right. If you “earn” interest through a high-interest account, you keep $1188. If you “save” interest with an offset, you keep the whole $2100.
And the higher your income, the bigger the advantage an offset/redraw account is. If you earn over $80,000 a year, you only get to keep $1107. And for those on $180,000-plus, you only get to keep $963.
Now, let’s compound those figures over 20 years.
The $30,000 in the offset cut your home loan by $86,090. It’s shaved more than three years off your home loan, meaning ownership comes sooner, which means no mortgage.
Now, the interest-bearing account. Here’s what’s happened:
- Someone earning up to $80,000 has saved an extra $33,740.
- Someone earning $80,000 to $180,000 has saved $31,924.
- Someone earning $180,000-plus has saved $26,436.
Simply, you are $50-60,000 better off with that $30,000 against your home loan over 20 years.
If you’re the sort of person who sees money in your accounts and spends it, then you’ll find the money and spend it, no matter whether it’s in high interest account or your offset.
However, if you’re serious about saving for your future, and you’ve got a home loan, then offset and redraw accounts are, literally, more than twice as good.
To claim anything else is, like Lance, “dope on a world-class scale”.
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Bruce Brammall is the author of Debt Man Walking (www.debtman.com.au), a licensed financial adviser and mortgage broker. firstname.lastname@example.org.
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