Have you made extra repayments on your home loan but are wondering if it would be better to redraw on your mortgage or take out a personal loan?
Good question. In this guide we’ll provide you with a cost comparison of each option to help you decide which you should go for.
Let’s start our comparison by using the example of homeowners Michael and Emily who are looking to add a $20,000 new kitchen to their house. Shall we crunch the numbers?
Say Michael and Emily take out an unsecured personal loan with the average variable rate at the time of writing of 13.12%.
Using our personal loan repayments calculator, if they paid the loan back over a 5 year period Michael and Emily’s monthly repayments would be $456 and they would pay $7,377 in interest.
Total interest paid: $7,377
By comparison, let’s see how much it would cost Michael and Emily if they dipped into the extra repayments they’ve made on their home loan.
Using the average variable home loan rate at the time of writing of 4.70%, if Michael and Emily have 20 years remaining on their $500,000 home loan, their monthly repayments would increase by $129 to accommodate the $20k redraw and they would pay $10,888 in interest.
Total interest paid: $10,888
You might be surprised to see that the home loan turned out to be the more expensive option, even though the home loan interest rate was considerably lower than the personal loan rate.
The problem with the redraw facility is that Michael and Emily wouldn’t be forced to pay it off sensibly, as they would be with a personal loan and the extra debt could sit around for 20 years.
If Michael and Emily were savvy and decided to make repayments on their home loan at the higher level required by the personal loan at $456 per month instead of $129. With some super-human self-discipline, they'd benefit from a lower interest rate and the shorter borrowing term and thus pay off the $20,000 redraw in just 4 years, at a borrowing cost of $1,978.
Total interest paid: $1,978
As you can see the home loan paid back over a shorter timeframe was by far the cheaper option but you’ll have to ask yourself “Will I actually make the higher repayment?”
Now that we’ve given you a cost comparison let’s delve deeper into each option…
If you decide that you’ll go for a personal loan, you’ll be applying for a completely separate banking product to your home loan and will need 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: As mentioned above, at the time of writing the average variable interest rate was sitting at a steep 13.13%. But if you use an asset like your car, property or expensive household item you could bring down this rate considerably to under 10%. But only choose the secured loan option if you are 100% sure you can service the loan, as putting up an asset means the lender can seize it if you forfeit on the loan.
Unsecured: The complete opposite to a secured loan, 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. But the downside, is of course, you’ll 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. Of course, there is one major setback that comes with fixed rate loans - a breakcost fee. This could be charged if you try to pay out the personal loan earlier than the agreed timeframe.
Variable rate: Alternatively, you could choose a personal loan that has an interest rate that is 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.
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 budget for paying an upfront fee to the lender. Some lenders waive this fee if you’re securing the loan with an asset.
Ongoing fee: For providing you with the loan, on top of the interest rate charged you could be charged a monthly ongoing service fee. Make sure the low rate outweighs the cost of this fee, otherwise it might be worth looking for a loan without any ongoing fees.
Breakcost 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 fee.
Quick tip - 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.
And don’t forget to look for flexible features:
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 fee free extra repayments.
Redraw facility: Since you’re reading this guide you’re probably pretty 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, make sure your personal loan comes with 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.
Let’s move onto the alternative option of a mortgage redraw. How it works is when you have made a considerable amount of extra repayments or lump sum payments on your home loan, you could potentially dip into that amount.
For example if your regular monthly repayments were $500 and you upped them to $600, and made a lump sum payment of $1,000, at the end of the year you would have made $2,200 in extra repayments that you could potentially draw on through your redraw facility. If you made the same extra/lump sum payments for five years you would have $11,000 that you could potentially dip into.
Now let’s answer some of the frequently asked questions around redraw facilities:
Each lender will have their own minimum and maximum redraw amounts that you’re allowed to dip into. For instance, at the time of writing one major bank had a minimum redraw of $2,000, with no maximum redraw limit.
Yes you may be charged a fee each time you redraw. That same big bank charged a $50 redraw fee for both over the counter or electronic redraws.
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.
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 or have a chat with one of our home loan negotiators who can help haggle a great deal on your behalf.
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 loan pros:
Personal loan cons:
Home loan redraw pros:
Home loan redraw cons: