11Paying 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.
Redraw facility explained
with tips to lower your mortgage!
Redraw facility has become a standard on many loans. But how do they work and what to look for?
With the majority of lenders now offering a product that allows the borrower to use their home loan as a transaction account, the lesser flexibility offered by a simple redraw facility may seem a bit out of date.
However, this is not necessarily 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-in-one loan or an offset loan.
Additional repayments
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, say, regularly paying $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, an extra $50, 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 redraw facility.
However, if you decide to keep this on your loan, these additional repayments would reduce the amount of interest you repay over the term of the loan and shortens the time it takes to pay off the loan.
For example:
If you have a $100,000 loan, with a 25-year term, an interest rate of 7.5% and principal and interest repayments, the minimum monthly repayment should be about $740. If the interest rate remained unchanged for the 25 years of the loan the total amount of interest repaid will be close to $121,700. You also have to repay the principal you borrowed, $100,000.
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.
Loan amount: $100,000
Loan term: 25 years
Interest rate: 7.5%
Monthly repayment: $740
Extra repayments per month: $100
Total monthly repayment: $840
Interest savings: $32,000
Loan term: reduced by 5 years and nine months
Consider another example where you pay the minimum monthly repayment each month but every 12 months you make a lump sum repayment of $1,000. Again the saving is substantial. The loan term is reduced by five years and nine months and more than $32,000 less interest is repaid (it is possible to model scenarios such as these using the Advanced Repayment Calculator).
If you are in a position to do so, making additional repayments can significantly reduce the length and cost of your loan.
Redraw facilities
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 – withdraw any additional home loan repayments you have made. Redrawing additional payments you have made will reduce the benefit of making additional repayments but knowing you are able to redraw additional repayments if necessary can allow you to increase the extra amount of repayments you pay.
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:
- the fee for having a redraw facility
- the number of free redraws per year
- the fee per redraw
- the maximum number of redraws per year
- the minimum redraw amount
- the maximum redraw amount
The fee for having a redraw facility
Some loans charge a flat fee for having a redraw facility. In some instances this 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 redraw facility. Once the redraw facility is activated the borrower can use it as often as they like.
The 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 between lenders and loans. Some lenders charge up to $50 per redraw, while others charge nothing at all.
The number of free redraws per year
Some redraw facilities grant the borrower unlimited free redraw 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 $25 fee on the fifth redraw of the year and any further redraws they make in that year.
The 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 additional repayments they have made.
The minimum redraw amount
Redraw facilities often have a minimum amount which can be withdrawn. With some loans there is no minimum, with others it is as high as $5,000. This determines the true flexibility of a redraw account and is the main difference that sets it apart from an all-in-one account.
The 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 as the total of additional repayments less one months repayments while others set a fixed amount, say $5,000, that you can withdraw regardless of how much more extra you may have paid.
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.
Mortgage savings
A home loan which 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.
- Firstly, by putting excess funds into your home loan they are effectively earning the interest rate on your home. Savings accounts generally pay much lower interest rates.
- The second advantage is that even though you are effectively earning a higher interest rate than if your money was in a savings account, you do not have to pay any tax, whereas interest earned in a savings account 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 an effective way of doing this. Say you put $100 a week extra towards your purchase. After 18 months you will have made close to $8,000 in extra 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, redraw facilities 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. As to redraw fees – a high redraw fee might be more beneficial to one borrower that knows that self control is lacking where the reverse is true of someone with good self control,” he says.
Knowing that an overpayment facility with redraw might actually cost you if you need to take some money out – many borrowers might actually find themselves wondering whether the redraw option is really worth it.
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 every blue moon, so the fee doesn’t really matter. But other borrowers will want their salary to go in each fortnight, and 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 its free every time.”
“Basically, different loans have different facilities – so when choosing their loan borrowers should talk to their bank or broker and get the loan that suits them”.
Some loans charge a flat fee for having a redraw facility. In some instances this 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 redraw facility. Once the redraw facility is activated the borrower can use it as often as they like.
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 in 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 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 access 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.”
Source: Your Mortgage Magazine *This article was first published in the February, 2009 issue of Your Mortgage magazine.
Remember, there is also the option of having a 100% offset linked to your home loan which can save you even more money however that is another story that takes a bit longer to explain. If you would like to know more in regards to a redraw account or even the potential of even greater savings through a 100% offset account please call one of our friendly home loan consultants on 83 600 200 and they’ll be happy to explain it to you.
