Q: I have a home loan that eats up a lot of my income each month. I am trying to decide whether to keep making repayments at the current level or get some income back for the family budget. How much benefit do I actually get if I pay extra each month? And what is the best way to do it?
A: AMP Bank issued some modelling last week, which shows that a home buyer with an average sized $400,000 loan would pay off their loan almost two years sooner and reduce the total payout by more than $20,000 by paying an additional $20 a week.
By paying an extra $50 a week, someone with a $400,000 loan would pay off the loan four years ahead of schedule and reduce the total payout by more than $45,000.
Most of the big lenders have calculators on their websites. You can do your own calculations. There is an obvious benefit in making extra payments, if your budget can handle it.
As to the best way to do this, most home loans offer offset or redraw options. They provide similar benefits but operate a little differently.
Canstar defines an offset account as a transaction account that is linked to the home loan and has normal transaction account functionality. The benefit of having one is that the balance of the account is offset against the balance of the home loan, and this reduces the interest charged.
Canstar says that 43 per cent of financial institutions offer offset accounts, although some only offer partial offsets.
A redraw facility allows borrowers to make additional deposits in their mortgage accounts. Those deposits are offset against the balance of the home loan, reducing monthly interest calculations.
Money in a redraw can be withdrawn but is usually not available for same-day, at call withdrawal in the way money in an offset account is. There may be a minimum redraw amount and there may be a limit on how many redraws you can make in a year. There may be a fee for redrawing.
Canstar says the advantage of an offset account is that it reduces the interest cost on the home loan, while providing day-to-day access to the cash for transaction.
The advantage of a redraw facility is that the money is going into the home loan account. It is better suited to people whose priority is to focus on paying off their mortgages.
Researcher RFi says borrowers should be aware that offset accounts are a premium feature and, in some cases, come with a fee.
RFi says offsets are the fifth most important consideration when borrowers are choosing a loan, after interest rates, broker recommendations, fees and an existing financial relationship.
For borrowers to get value out of an offset that charges a fee, they would need to evaluate how much they should hold in their offset account to compensate for any fees and determine whether it is viable, RFi says.
“A borrower who pays $400 a year to have access to an offset account would need to hold $10,000 in the account to break even at a mortgage rate of 4 per cent.”