Mortgage redraw vs personal loan

Australians wanting to access finance to pay for personal projects may have several options available to them. Australians who are also home owners may have extra choices to consider, such as deciding between applying for a personal loan or using the redraw facility from their mortgage.

How does a personal loan work? 

A personal loan can work similarly to a home loan, though on a smaller scale. You still apply to borrow money from a bank or similar lender, to be paid back in instalments plus interest over a pre-set length of time.

However, personal loans tend to be for smaller sums than home loans, often maxing out at somewhere between $60,000 and $100,000. They also often have shorter loan terms, measured in years, not decades.

Personal loans may have fixed or variable interest rates, much like home loans. However, because personal loans generally have shorter loan terms, a fixed rate personal loan’s repayments will remain fixed for the full term, and won’t eventually revert to a variable rate like with a home loan.

Much like how a mortgage is secured by the value of the property, it’s possible to secure a personal loan with the value of an asset. This could be the product being purchased (such as many car loans), or another asset such as equity in a property, money in a term deposit, or shares. It’s also possible to apply for an unsecured personal loan, though you’re more likely to need an excellent credit score and pay a higher interest rate.

How does a redraw facility work? 

Many home loans offer borrowers the option to make extra repayments on top of their regularly scheduled repayments. This can help to lower the remaining mortgage principal, bringing the borrower closer to exiting their loan earlier, so they may be charged less interest over time.

Some mortgage lenders allow borrowers to redraw any extra repayments they’ve previously made, taking this money out of the loan and putting it back into their bank account. So even if you put your spare savings towards getting ahead on your home loan, you’ll still have the option to access these funds if you need them.

Keep in mind that you can only redraw extra repayments you’ve made – you can’t redraw your regular monthly repayments. Also, some lenders limit how much money you can access with each redraw, or how much you can redraw per year. Others may charge fees for accessing your redraw facility.

Is a personal loan better than a mortgage redraw? 

There are advantages and disadvantages to both personal loans and home loan redraw facilities. The best choice for you may depend on your financial situation and your personal goals, as well as what you plan to do with the money.

Applying for a personal loan can let you access the money that you need, and the regular repayment schedule means you can be confident it will be paid back over time, with less risk of debt spiralling out of control. However, there’s no guarantee that your personal loan application will succeed – if you have bad credit, or your debt to income ratio is already too high, a lender may not approve your application.

A redraw facility can offer options for how you use your money, and doesn’t involve applying for an all new loan. But you’ll need to keep in mind that your budget will be limited by the extra repayments you’ve made previously. Also, redrawing your extra repayments means they’re no longer lowering your mortgage principal, so you may not get to pay off your property sooner and save as much money on interest charges.

What other alternative options could be available? 

Making extra repayments onto your mortgage could help to build up the equity in your property. While using your redraw facility could lower your equity, you may instead have the option to put it to work for you.

Home owners may be able to use the equity in their property as security for a personal loan, which could have a lower interest rate than an unsecured personal loan. Alternatively, this extra equity could allow a home owner to refinance their mortgage and borrow the extra money they want.

A borrower could also refinance to access a line of credit, which works similarly to a credit card with a credit limit based on their usable equity in the property.

Keep in mind that these options could mean the mortgage takes longer to pay off, potentially costing more in interest charges over time.  

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