Redraw or Offset advantage

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From: Gunna Doit


Could someone tell me if I'm understanding this right?

My idea goes like this - Say I have a loan for my IP, with a 100% (or close) offset a/c with it. The interest repayments were $20/wk IO or $70/wk P&I (pretend figures). If I chose an IO Loan, paid the $20/wk off the loan and put $50/wk into the offset a/c, wouldn't that give me the same advantage as the lower interest charge of a P&I loan, but with flexibility of drawing on the extra money if needed? I hope this makes sense, I've rewritten it three times!

Also, what are the advantages/disadvantages of the redraw and the offset a/c's. Is one better than the other?

Thanks guys.
Gunna
 
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Reply: 1
From: Rolf Latham


HiGD

On the button - you got it right as I see it.

Offset can be a bit more exxy on rate than basic redraw rate. Do your sums as to the value.

Sometimes a combination of the two loan types gives you the best outcome - a cocktail loan where the majority of the debt is on a budget redraw loan and say 20 k on an offset rate. If you are borrowing > than 250 k the difference between discounted rate offset and redraw rate in terms of your cost is minimal.

Ta

Rolf
 
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Reply: 1.1
From: Kevin Frey


This does not seem right in my opinion. I accept that your figures are pretend but it is worth noting that for P&I repayments to be 3.5 times that of IO repayments would require an interest rate of about 1.75%!

Anyway, onto your question ...

To get the same benefit out of the IO loan at a higher interest rate than the P&I loan at a lower interest rate will require you to contribute an amount equivalent to the "principal reducing" component of the P&I loan repayment to your offset account each week.

Using your figures, the IO loan repayment is $20/week, and the P&I repayment is $70/week.

If the IO loan repayment is $20/week, and if the P&I loan is at a LOWER rate of interest, then it naturally follows that the interest component of the P&I repayment MUST be LOWER than $20 per week. Which means you have reduced the principal of the P&I loan in the first week by MORE than $50, whereas in your example you have only put $50 into your offset account. In other words your offset account has not increased by the same amount as your principal would have decreased had you used the lower interest rate P&I loan.

Let me use some REAL numbers:

$100,000 loan.
P&I Interest Rate 6.50%
IO Interest Rate: 7.00%

P&I repayments (over 25 years) = $675.21 monthly.
IO repayments = $583.33 monthly.

As it turns out, on the very first P&I repayment the interest component of the $675.21 payment is $100,000 * 6.5% / 12 = $541.67.

This means, for the P&I loan, you have reduced your principal in the first month by ($675.21 - $541.67) = $133.54.

Now let's just say you want to pay the same amount against IO and the offset account.

In this case you pay the IO interest bill of $583.33, leaving you ($675.21 - $583.33) = $91.88 to put into your offset account.

The difference of $133.54 - $91.88 = $41.66 is how much you are behind in the first month.

To get the equivalent benefit you would have to contribute another $41.66 to your offset account to leave you in the same position, which means you have really paid out $675.21 + $41.66 = $716.87.

It is also worth noting that if you really want to do this you will technically have to vary the amount you contribute to the IO versus Offset account each month because, due to your offset account, your IO interest bill will be decreasing each month (in which case it would be easier for the bank to deduct the interest from your offset account each month if possible, and save hassles).
 
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