Retirees have been left out in the cold during the coronavirus pandemic as traditional income streams run dry.
The sharemarket’s collapse and diminishing bank dividends, along with falling rates on savings accounts and term deposits, have left many concerned about their financial welfare.
But there could be a saving grace for those with a mortgage and extra repayments: Offset accounts.
Their value was brought to the fore when ME Bank made controversial changes to redraw facilities that affected more than 20,000 customers.
ME Bank eventually reversed its decision on May 8.
Centaur Financial Services managing director and financial adviser Hugh Robertson said the saga highlighted the low levels of financial literacy around both options.
“If you talk to the majority of people, they would assume they are one and the same,” Mr Robertson told The New Daily.
How do redraw facilities and offset accounts work?
Both redraw facilities and offset accounts allow customers to reduce the amount of interest paid on their mortgage, shaving years off the life of a loan.
Redraw facilities enable home loan customers to withdraw at a later date repayments made on top of their minimum requirements, but the extra funds are housed inside their home loan.
For example, if a customer’s average monthly repayment is $1000 but they repay $1200, they would have $200 available to redraw.
In comparison, offset accounts sit outside a loan and effectively reduce the principal on which interest is payable.
So, if an offset account has a balance of $10,000 and is linked to a $300,000 home loan, interest would be paid on $290,000.
What are the main differences?
Although redraw facilities enable home owners to use extra repayments in times of strife, there’s plenty of risk because it’s attached to a mortgage, Mr Robertson said.
For starters, these repayments belong to the lender, who can access the redraw facility at will.
Most banks can also impose a maximum withdrawal limit and adjust the amount of redraw in a home loan, depending on the contract’s fine print.
And crucially, the government’s guarantee for deposits of up to $250,000 under the Financial Claims Scheme (born out of the Global Financial Crisis) does not cover redraw facilities.
So if your lender becomes insolvent, those extra repayments are not protected – but will go towards the outstanding balance on your mortgage.
These changes are usually communicated to customers before being enforced.
Offset accounts largely function as everyday bank accounts and can be accessed at any time, though some require withdrawals to be transferred to a separate savings account.
There are two main types of offset accounts: Partial offset accounts, which have lower fees but only offset the customer’s mortgage by a portion of their account balance (by 50 per cent, for example), and 100 per cent offset accounts, which have higher fees but offset the entire account balance against the home loan.
In either case, any money left in the offset account is guaranteed by the government up to $250,000, which protects customers’ savings in the event a lender becomes insolvent.
Although most offset accounts offer higher interest rates than savings accounts (as they are based on home loan rates), they charge monthly or yearly fees that sometimes overshadow the interest saved.
“Anyone with debt should try to utilise an offset account if they can and [use it to] pay all of their living [expenses],” Mr Robertson said.
“Offset accounts are the utopia for bank accounts in Australia.”
How do I figure out what option is right for me?
Mr Robertson said prospective property investors would benefit more from offset accounts, as they reduce a loan’s interest and would allow them to use the extra cash as the deposit for their next home.
Investors often use interest-only loans to fund their purchases.
However, home loan customers who are less confident in their spending habits may find redraw facilities reduce the temptation to take out money because of their bank’s imposed limits.
Either way, customers should reflect on their financial circumstances before deciding what’s suited to them.