Redraw and offset facilities can be tax-effective ways to save, but there are pitfalls that must be avoided.

Using your mortgage as a place to save gives you the best after-tax return outside super.

But financial advisers warn there can be traps if you’re not disciplined.

Anyone with a redraw facility or offset account can, in effect, ”save” by putting money on, or alongside, their mortgage.

With a redraw facility, the money goes in as an extra repayment, with the ability to redraw it if needed.

An offset account works slightly differently, sitting alongside the mortgage. If it’s a 100 per cent offset account, any money in the account is fully offset against your mortgage and you pay interest only on the balance left after that.

So, for example, if you had a $350,000 home loan and $50,000 in the offset account, you’d pay interest on $300,000.

Because you continue to make your usual monthly repayment, the impact of extra repayments and offset deposits is that you pay your loan off faster.

And because you’re not actually earning interest, there’s no tax to pay on those savings.

A minority of offset accounts provide only a partial offset.

In this case you’ll pay interest at a reduced rate on the amount of home loan equal to the money in the offset account.

In the example above, you might pay 5 per cent, instead of 6.5 per cent, on $50,000 of your home loan.

Redraw and offset were once features of ”premium” loans but have become more standard in recent years.

Nevertheless, check you won’t be hit with extra monthly or annual fees or a higher interest rate on the sort of loan that comes with this kind of facility.

If so, do the sums to see whether you’d be better off taking a basic loan with a low interest rate and no fees. On the RateCity database, loans with offset or redraw had interest rates ranging from 5.65 per cent to 7.46 per cent, application fees ranging from zero to $795 and annual fees ranging from zero to nearly $400 – all much the same span as for home loans in general.

If the facility is attached to a basic home loan, there can be a fee for redrawing. McPhail HLG Financial Planning principal Anne Graham says using redraw and offset are tax-effective ways of saving. But such facilities – including line-of-credit loans – require discipline. ”People get trapped when they don’t keep track of what they’ve taken out,” she says.

”They’re feeling good that they’re paying a lot off but they forget about the money that comes back out.

”They can end up with no movement at all in the [home loan] balance.”

Also, care needs to be taken if you want to use the money you’ve parked in your mortgage to help buy an investment property.

”It’s very important that you separate the interest charged on the amount used for investment purposes versus the interest charged on your home loan – the reason being that the investment-loan interest is tax deductible and the home-loan interest is not,” Hewison Private Wealth client adviser, Andrew Hewison, says.

That can be a little messy with redraw. So Hewison’s advice is to refinance, take what was the redraw money and establish a separate investment loan account.

Key points

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Posted by Lesley Parker – Fairfax Money Manager on 4th July, 2012