Offset Account vs Redraw: The Tax Trap That Costs Investors Thousands
Both save the same interest. But if your home ever becomes a rental, redraw can permanently destroy your interest deductions. Worked example, when redraw is fine, and the right offset strategy for investors.
An offset account and a redraw facility both cut your interest bill by the same amount. A dollar in offset and a dollar of extra repayment each save you the loan rate on that dollar. For a home you will live in forever, the difference is mostly about convenience.
For anyone who might ever turn their home into an investment property, the difference is enormous. Choose wrong and you can permanently lose tens of thousands of dollars in tax deductions.
How each one works
Offset account
A separate transaction account linked to your loan. Its balance is subtracted from the loan balance before interest is calculated. The loan itself doesn't change. Your money stays in your account, and you can spend it with a debit card like any other account.
Redraw facility
You make extra repayments directly into the loan, reducing the balance. The redraw facility lets you take those extra repayments back out. Legally, money you redraw is new borrowing from the bank, not your savings.
The interest saving is identical
$600,000 loan at 6% interest. You have $50,000 in savings.
That last point is why both beat a savings account. $50,000 in a savings account at 4.5% earns $2,250, but at a 37% marginal rate plus Medicare you keep only about $1,370. The offset saving of $3,000 is tax-free. An offset effectively pays you the mortgage rate, after tax.
The tax trap: what happens when your home becomes a rental
Say you live in the home for five years, then move out and rent it. The loan is now an investment loan, and the interest is deductible against the rent. But deductibility depends on what the borrowed money was used for.
If you used an offset
Your loan balance is still $600,000. You withdraw the $50,000 from the offset to use as a deposit on your new home. That was your own money, so withdrawing it creates no new debt. The full $600,000 loan was used to buy what is now an investment property, so interest on all of it is deductible.
If you used redraw
Your loan balance is $550,000. You redraw $50,000 for your new home deposit. The ATO treats that redraw as a new $50,000 borrowing used for a private purpose. Only the original $550,000 relates to the investment. Interest on the $50,000 is not deductible, ever, even though the loan is back to $600,000.
Over a 20-year hold that is more than $23,000 in lost tax refunds, and it gets worse with larger balances. You also end up with a mixed-purpose loan that is a headache for your accountant every year.
When redraw makes sense
- You are certain the property will always be your home
- Your lender charges a meaningfully higher rate or fee for an offset package
- You want a small barrier against spending the money
- You are on a fixed-rate loan that allows limited extra repayments but no offset
Strategy for investors with a home and a rental
Put every spare dollar in the offset against your home loan, not the investment loan. Home loan interest is not deductible, so reducing it saves you the full rate. Investment loan interest is deductible, so reducing it saves you only the after-tax rate. Many investors keep the investment loan on interest-only for the same reason. See our guide on interest-only vs principal and interest.
What an offset costs
Offsets usually come in a package loan with an annual fee of $0 to $400, or on a basic loan at a slightly higher rate. On a $600,000 loan, a 0.1% rate difference costs $600 a year. Run the numbers: if your average offset balance is small, the package may not pay for itself. If you might ever rent the home out, the tax protection alone usually justifies it.
Plan the whole purchase, not just the loan
Loan structure is one lever. The postcode you buy in is the bigger one. PropPulse reports show repayments, yield and estimated cash flow for every Australian postcode. Get a free report.