What is a redraw facility?
Sep 16 2014
Posted by Adam Beu on 03/02/2015
When it comes to home loans. redraw facilities are a common offering. But – what actually is a redraw facility?
A redraw facility can be a complicated concept to wrap your head around, but may also be invaluable in cutting years off the life of your home loan without locking up all of your savings .
Redraw facilities are a feature attached to loans (namely home loans and personal loans) whereby account-holders can withdraw money they’ve already contributed to pay off their loan. The balance of this facility consists of whatever extra payments the borrower has already made towards paying off their loan.
The benefits of a redraw facility
The major selling point of redraw facilities is the compound interest earned on your repayments. Because the interest you are being charged on your home loan is likely to be higher than the interest rate you are able to achieve on any cash savings account, it’s a good deal. E.g.:
Sarah makes $4,000 in extra repayments towards her variable rate home loan over four months, but halfway through the fourth month she needs some of that money to pay off her credit card debt.
Her home loan redraw facility allows amounts over $500 to be withdrawn, so Sarah withdraws $1,000 to contribute to her credit card.
The amount owing on the life of her mortgage has been reduced thanks to the four and a half months excess savings in her account. She has the extra money to pay her credit card debt plus the benefit of the $3,500 left in her redraw account for future growth.
Many loan holders will find
– if they’re disciplined with their money – a redraw account goes a long way towards paying off a loan while still providing a contingency to pay off future debts. No matter what the money is spent on eventually, you can rest easy in the knowledge that the amount owing on your loan was reduced while you had that extra money in your account.
You should also be aware of the tax advantages of using this facility, because while any interest earned an a cash investment will be taxed at your marginal tax rate, any interest that you save on your home loan by holding money in a redraw facility will not be subject to tax. E.g.:
Sam inherited $20,000, and decided to put this money into a term deposit. He was able to earn 4% interest on this amount – but once he paid tax on this interest at his marginal tax rate of 32.5%, his after-tax (net) return was only 2.7%. This was much less than the interest rate of 5% being charged on his home loan.
The disadvantages of redraw facilities
While the advantages are significant, you should be aware that there can be fees and withdrawal restrictions tied to each redraw that you want to make, as well as limits pertaining to how many redraws you can perform per year. AS such, the money that you pay into a redraw facility ideally shouldn’t be money that you’ll need to use a few weeks later!
Making it more difficult to redraw funds on a regular basis, however, may not be such a bad thing as this effectively deters you from redrawing too often and saves you money in the long run.Source: www.canstar.com.au