Which should I choose? Personal loans vs home loan redraw

Got a large expense coming up that needs covering? Maybe you're planning a dream holiday or doing some major home renovations and need the extra cash. If you've been wondering how to finance your plans, you actually have some options.

If you're having trouble choosing between a personal loan and a home loan redraw, we're here to debate the differences and help you decide which one is the best option for you.

To really get to the bottom of the differences between your options, let's look at how the different options play out.

Imagine you're looking to do a $20,000 update to your kitchen. Here's how that ends up looking:

1) Personal loan

You choose to take out an unsecured personal loan with the average variable rate at the time of writing of 9.75% p.a. - and we're going to assume you snap up a great deal with no establishment or monthly service fees!

Using our personal loan repayments calculator, we can work out that on a 5 year loan, your monthly repayments would be $422. We can also work out how much interest you'd pay over the total life of the loan.

Total interest paid: $5,349

2) Home loan redraw

By comparison, let’s see how much it would cost you if you dipped into the extra repayments on your home loan.

Remember, this is only a viable option if you have been making extra payments on your mortgage and you have the money available to redraw. Also make sure that your home loan allows for redraw, as many lenders charge for this or restrict the ability to redraw.

For this example, let's imagine you have $500,000 home loan.

You've been working hard over the years to make extra repayments to pay things off sooner, and have contributed an extra $20,000 towards your home loan.

Imagining you're paying the variable home loan rate at the time of writing of 5.00% p.a. By being ahead of your mortgage by $20,000, you'll be saving $30,103 in interest in the long run - use our home loan extra repayments calculator to see what difference extra repayments will make.

Now, you're looking to redraw that same $20,000 from the extra payments to use for your kitchen refreshments.

By taking back out that same $20,000, you'll end up having to pay all of that extra interest on your home loan. That means the total interest on your home loan will go from $261,844 to $291,947. That's a pretty major change!

Total interest paid: $30,103

Even though personal loans may have higher rates than many home loans, they are paid off over shorter periods. It means considerable savings in interest, even though the interest rates might seem extremely different.

The other main difference is that there's no one forcing you to repay a home loan redraw. Since that money was an additional repayment to your home loan, the extra $20,000 could sit around as an extra weight on your mortgage for another 20 years. In order to make up for that extra money you had paid and redrawn, you would have to increase your monthly repayments considerably.

Now we've established the difference between personal loans and home loan redraws, let's look a little bit deeper into each option.

If you decide to go for a personal loan, you’ll be applying for a completely separate banking product to your home loan. It's important to check that the personal loan is not only the right type of loan but has the features that will work for you as well. Here are some of the different types available:

• Secured: At the time of writing the average unsecured variable interest rate was sitting at 9.75% p.a. But if you use an asset like your car, property or other valuable possession, you could bring down this rate considerably: the average secured loan interest rate sits at 8.06% p.a. Only choose this option if you are 100% sure you can make your repayments, as the lender can seize your property if you default.

• Unsecured: An unsecured loan provides you with the peace of mind that your assets aren’t at risk in the case you are unable to repay the loan. The downside? You’ll generally be charged a higher interest rate.

• Fixed rate: Are you the type of person that likes consistency? Then a fixed rate loan could be for you, which means over the life of the loan your repayments will remain the same, as the interest rate is locked in. These can lack flexibility or be costly to break from, so do your research.

• Variable rate: Alternatively, you could choose a variable rate personal loan, subject to change with the market. This means you’ll benefit when rates are low but will need to budget for the chance of your provider lifting their variable rates.

Compare different options for personal loans using our personal comparison loan calculators.

Once you’ve decided what type of personal loan you’d like to go for, here are some of the fees to watch out for:

• Application fee: When you apply for a personal loan, you may need to pay an upfront fee to the lender. Some lenders waive this fee if you’re securing the loan with an asset. These are also referred to as establishment fees. 

• Service fee: On top of the interest rate charged, you could be charged a monthly ongoing service fee. Make sure the low rate and features of the loan outweigh the cost of this fee, as it can quickly get costly.

• Break cost fee: A fixed rate loan may provide you with great security against rate rises but if you try to pay it off early just be mindful that some come with the slap of a high breakcost or early repayment fee.

Extra repayment fee: Some personal loans will charge for the benefit of making additional payments - if they even have this facility. If you intend on contributing extra, make sure to check for this.

Check out what the comparison rate is for the personal loan, as this will give you an idea of how much the personal loan will cost once the headline rate and upfront and ongoing fees are merged together.

Don’t forget to look for flexible or additional features in your loan:

• Extra repayments facility: Just like with your home loan that allows you to make additional repayments, you can do the same with your personal loan if you take out one that comes with the option of extra repayments. Make sure you check for a fee!

• Redraw facility: You’re probably already familiar with a redraw facility, as you have one with your home loan. Well, that same facility is also available with many personal loans, which allows you to redraw on the extra repayments you’ve made on your personal loan.

• Repayment flexibility: If you do go for the personal loan option, look for a repayment schedule that suits your pay day. The more flexible personal loans will allow you to choose between setting up your repayments either weekly, fortnightly or monthly.

Whether or not a personal loan is the right option for you will come down to your personal circumstances, but let's look at the other option.

Home loan redraws can seem appealing, as it is simply you taking back money that you have already paid into your home loan.

Say your regular monthly repayments are $500, and you bump them up to $600 with some extra from your pay check. You score a neat little Christmas bonus and make a lump sum payment of $1,000. At the end of the year, you'll have made $2,200 in extra repayments - a handy little sum that could start your redraw facility.

If you made the same additional payments for five years, that's $11,000 that you could potentially dip into.

But redraws can be a little bit confusing, so let's answer some questions.

How much can I redraw?

Each lender will have their own minimum and maximum redraw amounts that you’re allowed to dip into. Some lenders have no minimum redraw limits or have different requirements depending on whether you withdraw at a branch or online. Make sure you read the fine print on your home loan to see what you are eligible for.

Will I be charged a fee for redrawing?

You may be charged a fee each time you redraw. Not every lender will charge for redraws, but some do, so it's worth checking.

How many REDRAWS CAN I MAKE?

Some lenders put a limit on redraws, so once again: it pays to read the terms and conditions on your home loan!

How can I access my extra repayments?

You’ll usually be able to withdraw the extra repayments you’ve made on your home loan through ATM withdrawals, EFTPOS, online banking or in branch. Refer to your lender for further information.

What are the alternatives to a home redraw?

Home loan top up: If you hold equity in your property, then an alternative option is to increase the limit of your current home loan. But just like when you redraw on your home loan, be mindful that a home loan top up will significantly hike up the interest you’ll pay in the long run.

Line of credit loan: Another option which is also based on the equity you hold in your property is refinancing your current home loan to a line of credit loan. These types of home loans provide you with a revolving loan facility that you can draw on whenever you like (to a capped amount). But keep in mind this will ultimately reduce the amount of equity you hold in your property.

To compare what’s on offer in the home loan world, punch your digits into our home loan comparison tool.

Okay, we are nearing the end of our guide, so what better way to finish than with a quick roundup of the major drawcards and setbacks of personal loans and home loan redraws:

Personal loans

Home loans

Want to start comparing personal loans? We've got a few listed below to get you started.

Considering a personal loan? Read our guide to easy personal loans to get you started. If you're keen to see some standout personal loans, have a look at our selections of best personal loans.