With the majority of lenders now offering a product that allows the borrower to use their home loan as a transaction account, the lower level of flexibility offered by a simple redraw facility may seem a bit out of date.
However, this may not necessarily be the case. Many loans with a redraw facility can represent value for money and see the borrower pay less interest over the life of the loan when compared to their more expensive counterpart – the all-inone loan or an offset loan.
To be able to use a redraw facility, you need to make additional payments on top of your minimum loan repayment schedule first. This includes one-off lump sum repayments or regularly paying, say, $50 more than the required minimum repayment.
For example, if your minimum monthly home loan repayment is $700 and for 12 months you pay $750 and make a lump sum payment of $2,000, the total of your additional payments at the end of this period will be $2,600. If you need some cash down the line, you can access this amount via the loan's redraw facility.
However, if you decide to keep these amounts on your loan, these additional repayments would reduce the amount of interest you pay over the term of the loan and would shorten the time it takes to pay it off.
If you have a $100,000 loan, with a 25-year term, an interest rate of 7.5% and principal and interest repayments to make, the minimum monthly repayment should be about $740. If the interest rate remains unchanged for the entire term of the loan, the total amount of interest repaid will be close to $121,700. And you also have to repay the principal you borrowed, which is $100,000.
In this scenario, the impact of additional repayments can be significant. By paying an extra $100 a month (a monthly payment of $840 instead of $740) the total amount of interest saved is more than $38,000 and the loan term is reduced by around six years and nine months.
Consider another example. Instead of making higher monthly repayments, you pay the minimum amount required each month but every 12 months you make an additional lump sum repayment of $1,000. Again the savings are substantial. The loan term is reduced by five years and nine months and more than $32,000 less interest is repaid. (You can model scenarios such as these using the Advanced Repayment Calculator on the Your Mortgage website – www.yourmortgage.com.au).
It is therefore clear that, if you are in a position to do so, making additional repayments can significantly reduce the length and cost of your loan.
Paying any extra money you have on hand into your home loan can be an easier decision when you know you have the ability to get these additional payments back at a later date.
A redraw facility allows you to do this – i e, withdraw any additional home loan repayments you have made. Redrawing additional payments, of course, reduces the benefit of doing this, but knowing you are able to redraw the additional payments if necessary can also allow you to increase the extra amount of repayments you make.
Understanding redraw facilities
As the terms and conditions of redraw facilities differ significantly among lenders, it is important to understand what’s on offer before you take out the loan. Before making any decision there are a number of details that first need to be checked. These include:
1. the fee for having a redraw facility
2. the number of free redraws per year
3. the fee per redraw
4. the maximum number of redraws per year
5. the minimum redraw amount
6. the maximum redraw amount
Fee for having a redraw facility
Some loans charge a flat fee for having a redraw facility. In some instances this fee is not charged upfront, rather it is described as a 'redraw activation fee' and charged only if and when the borrower wishes to use the facility. Once it is activated, however, the borrower can use it as often as they like.
Fee per redraw
The fee per redraw is the amount the borrower must pay each time they withdraw funds from their loan account using the redraw facility. This fee varies significantly among lenders and loans. Some lenders charge up to $50 per redraw, while others charge nothing at all.
Number of free redraws per year
Some redraw facilities grant the borrower unlimited free redraws while some lenders offer a number of free redraws per year. Once the quota of free redraws is exceeded, the borrower must pay the fee per redraw.
For example, if a redraw facility grants four free redraws a year and has a $25 redraw fee, the borrower only pays the $25 fee on the fifth redraw of the year as well as any other redraws they make in that year.
Maximum number of redraws per year
Some redraw facilities limit the number of redraws the borrower can make within a set period, usually a year. Once this number is exceeded the borrower cannot access any additional repayments they have made.
Minimum redraw amount
Redraw facilities often have a minimum amount that can be withdrawn from the loan. With some loans there is no minimum and with others it is as high as $5,000. This determines the true flexibility of a redraw account and it is the main aspect that sets it apart from an all-in-one account.
Maximum redraw amount
The maximum redraw amount is the largest amount you can withdraw at any one time. In most cases this is equal to the total of additional repayments you have made. So if you are $3,000 ahead of your minimum loan repayment you can redraw $3,000.
Some redraw facilities set the maximum redraw amount as the total of additional repayments less one month, while others set a fixed amount, say $5,000, that you can withdraw regardless of how much more you may have paid out on top.
Getting value for money
To be able to choose the most suitable redraw facility you need to have a good idea of how you are going to use it. There is no point paying for something you are not going to use. If you are unlikely to be able to make additional repayments on your home loan in the foreseeable future there is not a lot of point in paying a higher interest rate to have a redraw facility on your home loan.
A home loan that allows additional payments and has a redraw facility can be an excellent savings tool. There are two main benefits to putting your money into your home loan rather than a savings account.
First, by putting excess funds into your home loan they are effectively earning the same as the interest rate on your loan. Savings accounts generally pay much lower interest rates.
The second advantage is that even though you are in fact earning a higher interest rate than if your money was in a savings account, you do not have to pay any tax on that income. Interest earned in a savings account, however, is considered income and may be taxable.
If you plan to save up over 18 months to buy a new car, using a home loan with a redraw facility can be a good way of doing it. Say you put $100 a week extra towards your repayments. After 18 months you will have made close to $8,000 in additional repayments – enough to buy a good second-hand car. You will also reduce the amount of interest you pay on your home loan and the time you take to repay it.
Used wisely, a loan with a redraw facility can be a cheap and effective way to minimise the amount of interest you pay on your mortgage while cost effectively using any excess funds you have at your disposal.
What to look for
When it comes to finding the best type of redraw/overpayment facility for you – there are just a few basic points to look for, according to Wayne Alpine of Money First Loans.
"Easy access – monthly mortgage charges should be small or nil," he says. "As to redraw fees – a high redraw fee might be more beneficial to a borrower who knows that self control is lacking, whereas the reverse is true of someone is good in this regard."
Knowing that an overpayment facility with a redraw component might actually cost you if you need to take some money out could prompt some borrowers to wonder whether the redraw option is really worth it considering their needs.
As Dean Gillespie, head of mortgages at BankWest, explains, it comes down to your own attitude and circumstances – and while the option to overpay AND redraw might suit some – it could be a drawback for others.
"It depends on how often the customer wants to use the redraw – some borrowers only want to deposit and withdraw once in a blue moon, so the fee doesn't really matter. But other borrowers may want their salary to go in each fortnight, then pull out money when they need it every few days," he says. "If they are going to use the facility frequently, they should pick a bank with online free redraw as it's free every time.
"Basically, different loans have different facilities – so, when choosing theirs, borrowers should talk to the bank or broker and get the one that suits them."
Is this the strategy for you?
Although overpayment and redraw facilities offer many advantages, the benefits work best with the right type of borrower, so it’s important to determine whether this facility will suit your circumstances and your personal approach.
"Customers who are more disciplined with their finances can gain more benefit from this type of facility," says Mark Jones, banking portfolio manager at AMP.
"Any customer can use facilities of this type, but the appropriateness of such a facility very much depends on the customer’s individual needs, objectives and circumstances, so all customers should take independent advice about what type of loan product and facilities are best suited to their particular circumstances."
Gillespie agrees and adds that borrowers considering redraw and overpayment facilities need to be aware of their own weaknesses in terms of financial discipline.
"Some borrowers may find that having access to a redraw facility makes it too convenient for them to get at their funds," he says. "Many people like to get ahead in their loan by putting extra money in, but then prefer it to be difficult to take out again! It’s a matter of personal preference – customers should have a chat to their bank if they are unsure."