What you must know about Line of Credit, Offset Account and Redraw facility
There is some confusion around the Line of Credit, Offset accounts and Redraw facilities that banks offer. When we talk to clients about what their understanding as to what each facility offers we find a range of answers – as important as it is to understand their benefits its also very important to understand what impact they can have on your strategy, especially with regards to taxation.
Lets have a look at each of these facilities in detail:
Lines of Credit
A line of credit is often referred to as a “home equity loan”, and it allows you to borrow money using your existing equity (calculated by taking the value of your home less monies owed on it)
A line of credit acts as a flexible transactional mortgage that allows you to access your funds when you need them and, as such, it can be used at your own discretion – for example, you may use such funds to pay for home renovations, property investments or personal purchases such as household items, cars or travel.
The danger with lines of credit is simply that, unless you are disciplined, you can often find yourself accessing the cash available via the LOC for “non-investments” – items that don’t provide a return and as a result, your debt isn’t reduced effectively, and in many cases, blows out of control. We recommend LOC’s for active accounts such as investment portfolios where you are regularly trading inside the account and looking to reconcile the balance daily, weekly or monthly.
These are the perfect tool for investment buffers and assisting with your investment property cash flows.
A redraw facility enables you to deposit any spare income you have directly into your home or investment loan account. You can then redraw from the loan account any funds that are in excess of your regular repayment schedule.
A redraw account can be very effective if you can foresee some changed circumstances – for instance, you can make additional payments whilst you have the capacity to be able to pay excess amounts into your loan in preparation for a time when this capacity may reduce – for instance, if you are expecting a child then you could accelerate your payments via this facility and then draw down on the excess once the baby has arrived.
We do not recommend redraw facilities on investment facilities as a general rule as this can “blend” the usage and complicate your taxation affairs.
An offset account is a transaction account that can be linked to your home or investment loan. The credit balance of your transaction account is offset daily against your outstanding loan balance, reducing the interest payable on that loan.
We love offset accounts! The funds are always available and yet, as they sit in the bank they work for you in reducing the interest accruing on the mortgage. Nice!
These are still widely underutilised and their simple effect can have dramatic savings for you over the life of a loan.
The main reason we prefer offset accounts to redraw facilities is that, whilst they have the same impact on your mortgage as you go, its when circumstances change that redraw facilities may restrict your capacity to achieve what you want. As an example, if you’re utilising a redraw facility and then you want to convert the property attached to the mortgage from your principal residence into an investment property, (changing the fundamentals of the loan) then you’re unable to access the excess funds that you have been paying into the redraw account – if you had been using an offset account on the other hand, then the funds sitting to the side of the mortgage are easily accessible.
At the end of the day, offset accounts are cash and available to use 100% at your discretion whereas redraw has limitations.
How easy is it to set up these facilities?
Thankfully, really simple! Its true that all the banks are a little bit different about how they manage the process, but we happily guide all our clients through what needs to be done with a minimum of fuss. The key issue is to talk through every client’s situation and individual circumstances to make sure they understand what we’re doing and why we’re doing it for them.