Offset or redraw: the difference that actually matters

An offset account is a transaction account linked to your home loan. The balance in it is subtracted from the loan balance before interest is calculated. Hold $20,000 in a full offset against a $500,000 loan and the lender charges interest as though you owed $480,000. The money stays yours, in an account with your name on it, and you can spend it tomorrow.

Redraw is different in origin. It is the pool of extra repayments you have already made, money paid into the loan above the required repayment, which the lender allows you to take back out. The balance genuinely fell when you paid it in, so the interest saving is identical. The difference is that the money now sits inside the loan rather than beside it.

That single structural difference drives everything else: how easily you can get at the money, what happens if the lender changes the terms, and how the Australian Taxation Office treats the loan if the property is, or later becomes, an investment.

Home loan interest in Australia is generally calculated daily and charged monthly. The lender takes the closing balance each day, applies the daily rate, and adds up the days in the billing cycle.

That daily calculation is why an offset works even on money you only hold briefly. Salary that arrives on the 15th and is spent by the 30th still offsets the balance for fifteen days. It also means the size of the benefit depends on your average balance across the month, not on the balance on any single day.

One thing to check on your own loan schedule: a partial offset account offsets only a proportion of the balance, while a full offset, sometimes called a 100% offset, offsets all of it. The word offset on a product page does not tell you which one you have.

General comparison of the two features. Terms differ by lender and by product, so check your own loan schedule and contract.

On an owner-occupied home none of the interest is deductible, so for tax purposes the distinction is irrelevant. It starts to matter the moment the property is, or might become, an investment.

The general principle the ATO applies is that the deductibility of interest follows the use to which the borrowed money is put. Not the security offered, not the name on the account. The use.

The purpose test

Interest is characterised by what the borrowed money was used for, rather than by what secures the loan or which account it passed through.

Redraw as new borrowing

Taking money back out of a loan is a fresh borrowing. Its treatment is judged on what you then spend it on, not on the fact that you had paid it in.

Mixed-purpose loan

A single loan carrying both deductible and non-deductible borrowings, which then has to be split between the two for the rest of its life.

Apportionment

Dividing the interest between the deductible and non-deductible portions. Repayments generally reduce both parts proportionally rather than clearing one first.

Take a loan on a property you intend to rent out later. If you hold $60,000 in an offset account against it and you withdraw that money to buy a car, you have spent your own savings. The loan balance returns to where it was and the purpose of the borrowing has not changed. If instead you had paid that $60,000 into the loan and then redrawn it to buy the car, you have borrowed $60,000 for a private purpose. The loan becomes mixed-purpose, and the interest has to be apportioned between the deductible and non-deductible parts.

Mixed-purpose loans are administratively miserable. Repayments are generally treated as reducing both parts proportionally, and you cannot simply direct repayments at the non-deductible portion to clear it first. That is the strongest argument for an offset over redraw on any property that could become an investment, and it is a reason to speak to your accountant before you make extra repayments rather than after.

Offset accounts are rarely free. They are commonly bundled into a package product carrying an annual fee, or offered on a loan priced above the lender's most basic option. Some lenders offer an offset on a no-frills loan. Many do not.

The arithmetic is simple enough to do yourself. The annual benefit of an offset is roughly your average offset balance multiplied by your interest rate. Set that against the annual package fee, or against the extra cost of the higher-priced loan, and you have your answer. If your average balance is small, the feature can cost more than it saves.

Three practical points are worth knowing before you choose a product on the strength of its offset account.

• Several lenders allow multiple offset accounts against one loan. That lets you separate an emergency fund from a tax reserve without losing any of the interest benefit, which is genuinely useful for anyone self-employed and setting aside GST and income tax.
• A fixed-rate loan usually restricts both offset and extra repayments, so an offset strategy and a decision to fix can work against each other. Splitting the loan is the usual way to hold both.
• An offset only works on money that is actually there. If the balance spends most of the month near zero, you are paying a package fee for a feature you are not using, and a cheaper loan without it may be the better structure.

1. 01

   You have surplus cash and may need it back

   Offset. Access is immediate and the money is yours, not a facility the lender can vary.

2. 02

   The property is, or may become, an investment

   Offset, almost always. Confirm your position with a registered tax agent before you make extra repayments into the loan itself.

3. 03

   You are self-employed and holding GST and tax money

   Offset, and use more than one account if your lender allows it. Money set aside for the ATO reduces your interest while it waits to be paid.

4. 04

   You struggle to leave savings alone

   Redraw. The friction is the whole point, and for some households it is worth more than the flexibility.

5. 05

   You have a basic loan with no offset and no plans to move

   Redraw is doing the same interest job. The real question is whether the loan is right, not whether the feature is.

6. 06

   You are on a fixed rate

   Check the annual extra-repayment cap and whether any offset is available at all. Splitting the loan is the usual answer where you want both certainty and flexibility.