Borrow More than What Is Needed and Keep Excess in Redraw Facility?

LKutchAu on 30/07/2022 - 12:25
Last edited 30/07/2022 - 13:02 by 1 other user

Hi OzBargain team, I know this is certainly not the best for financial life advice but I wanted to propose a question to see if it has an obvious answer I'm missing

I'm buying my first house currently and have preapproval for the same, and have found a house that was slightly below my estimated/max loan amount. Therefore, the amount I had set for deposit has some wiggle room as to how much I actually put up, and how much I decide to loan, and hold onto a portion of my deposit. I am looking at a principal and interest variable loan with a redraw facility.

My broker has hypothesised to me that for this loan type if I decided to loan less, my excess deposit money would be sitting in the redraw account, able to be accessed if needs be in case of emergency or other spending, but otherwise will in fact be reducing the total interest I owe each period to the point where I will actually be paying off more of my principal each pay period (apparently the total payment due is the same whether money is sitting in the redraw or not as its calculated on the total loan amount, but the actual interest I owe is reduced, so that difference I pay goes to the principal/actual loan amount itself)? I understand this would increase the total that I pay each period over X years because the loan and therefore calculated interest is higher, but I don't think it increases my actual interest compared to using up my whole deposit assuming that money just sits in the redraw account?

This would be within the same LVR bracket so my rates wouldn't change (i.e. 70-80% or 80-90% or 90-95%) but it was an interesting suggestion I hadn't really considered ups and downs to.

I hope that all my explanations make sense but essentially I'm asking: is there a potential benefit of having more money on hand and possibly slowly paying my (larger) loan off more quickly over time, with keeping some more of my deposit (within the same LVR bracket) to myself, or am I being had by the broker to borrow more and hence increase their commission?

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  HardQuiz on 30/07/2022 - 13:24

  +1

  Hypothetically, if the broker’s commission is the same no matter what you decide, what would you do ?

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    Kinko82 on 06/08/2022 - 19:22

    Mortgage brokers get paid a commission on the loan amount based on the net balance owing. That means, the broker will not get paid more either way.

    This regulation was put in place to prevent your type of thinking and assumption as a consumer so that consumers can feel confident the broker is acting in their best interest and not recommending a higher loan amount to get paid.

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  Transient on 30/07/2022 - 13:59

  +1

  One additional factor is that if you can borrow less (ie, less than 80% of the price) then you should be able to avoid the cost of paying lender's mortgage insurance (the % may have changed since I last borrowed).

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    Keplaffintech on 30/07/2022 - 14:11

    +2

    Also you can typically get better interest rates for reducing your LVR even further, e.g. 70 and 60

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  Worf on 30/07/2022 - 13:59

  If surplus funds sitting in redraw facility do not incur interest, then, the total interest paid should be the same for both scenarios all other things being equal.

  Maybe do a spreadsheet of your two scenarios. How is the broker paid, commission or flat rate?

  It’s good to have a buffer, the amount depends on your circumstances.

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  kawinuyo on 30/07/2022 - 14:02

  +6

  Yes. In regards to your question. I suggest rather than redraw do offset instead. Offset is 100% your own money, whereas redraw is more like, money that you've paid back early to the bank that they may allow you to take out again (I say may because lots of accounts has redraw limits). Both redraw and offset work the same way in reducing your interest.

  As for having more money on hand, our broker told us to borrow the max amount allowed while still in 80% and to put everything in offset because the end outcome is the same. This gave us more flexibility in terms of suddenly need much larger amounts for major renos, the covid situation, kids etc

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  aidenh37 on 01/08/2022 - 18:50

  Just get an offset and maybe a credit card. Then, all monies, including your daily spending funds, saves you interest. Getting a credit card leaves those funds in offset for longer and earns points, saving you even more.

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  Kinko82 on 06/08/2022 - 19:25

  I personally think it’s better to borrow the full amount and have the surplus on hand on redraw or offset so you can have access to cash if you ever needed it.

  If you ever needed the extra money in the future, you don’t have to go apply for it and sometimes you may not qualify to borrow or increase your loan.

  The broker will be paid the same amount either way you decide so you’re not being had by the broker.

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  zbys on 18/08/2022 - 12:29

  +2

  Assuming total outstanding (balance - offset) is the same, the interest charged is the same. Your broker is correct that the minimum monthly repayments will not change due to money in offset and interest will be reduced thus paying principal off sooner due to the reduction in interest. You can usually redraw this interest saving though to bring you "back in line" if you prefer. However, your minimum monthly payments will also be higher for the higher loan regardless of what's in the offset as the bank bases this only on the loan value. This may or may not be a good thing depending on your situation (pro - forces you to repay your loan faster by paying more than you would have otherwise / con - worse for cashflow flexibility).
  Usually an offset will come with a penalty of slightly higher % rate or annual fee.

  A few things to think about:
  How good are you with resisting the temptation of having money available? Are you likely to "dip in" to an offset account and spend it if it's available which you may not do if it's "locked away"?
  Are you intending to do anything other than living in the house for the long term? There may be advantages with the offset route if you ever convert your property to investment property later.
  Is your lender known to wipe your redraw value? This is especially risky if the lender goes under as they will sell your outstanding loan balance to someone else wiping your redraw - this has also been done by banks giving lenders a pretty nasty surprise.
  Is your offset account covered by the govt Financial Claims Scheme ($250k govt guarantee)?

  I would not be surprised if the broker gets more money with the offset option, because they would get paid on the loan balance - the bank has no idea what you're using this additional capital for. Putting surplus into an offset facility is not unusual even if it wouldn't stay there long term and there's no guarantee it'll stay there. I'd imagine the up front commission would be higher due to the higher loan amount. Trailing commission may not be higher, particularly if based on actual interest paid. Broker could be banking on you going on a spending spree and blowing the surplus funds in which case the trailing commission would be higher too.
  That said, it's not an unusual arrangement. You can redraw your loan to capture any capital gains over time too and it's the same concept, take out additional capital with your property being the collateral. It certainly gives you more flexibility, can be used to boost your investment amounts etc.

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    JIMB0 on 18/08/2022 - 12:49

    Which banks are known to restrict redraw?