Revolving credit: Key to paying off your home loan, or expensive headache?

Thursday, 11 April 2019

Upping mortgage payments by $10, $20, or $30 a week makes a huge difference to the time it takes to repay the loan, and the total interest paid.

If you have a mortgage, or are thinking about applying for one, you've probably heard about a 'revolving credit' facility.

Used well, this can save you a lot of money. But when it gets out of hand, it can end up being an expensive complication.

WHAT IS IT?

A revolving credit facility is often used like a big overdraft.

Each month, everything you earn goes into that account, to reduce the amount of interest accruing on that borrowed money.

You then put all your living expenses on your credit card, pay your bills at the end of the month and repeat.

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The more money you build up in the account, and the longer it sits there, the more you save.

FOR

So should you do it?

You can save thousands. Or you could end up still stuck in debt and paying a higher interest rate for it.

If you manage it well, you save a significant amount of money.

Financial adviser Liz Koh said people would be able to knock down a mortgage more quickly this way.

If you and your partner each earn $4000 after tax monthly, you could reduce the amount of your loan accruing interest by $8000 for many of the days of each month, by doing virtually nothing. This could save you tens of thousands of dollars over the course of your loan.

But she said it could also be used more aggressively - and can be set up separately from your main transaction account, if that's easier for you to manage.

It was a good way to save money, she said, because it was still accessible.

'If have a line of credit of $50,000 and repay $20,000, you can take back the $20,000 at any time without needing the approval of the bank. This means all your spare cash can be paid into the line of credit to keep interest payments down and drawn down if and when needed,' she said.

Here's how to get on top of your mortgage.

'Let's say you have a mortgage of $300,000 and, with two incomes in the household, you believe you can save $1000 per fortnight. You can set up a line of credit of, say, $30,000 and two table mortgages, one of $135,000 with an interest rate fixed for one year and one of $135,000 with an interest rate fixed for two years. Each fortnight you pay $1000 into your line of credit so that, by the end of a year, providing you have not needed the money for anything else, the balance is now down to $4000 owing and you can draw down up to $26,000 if required.

'The chunk that was fixed for one year is now waiting to be fixed again, but before you do so, you can draw down, say, $20,000 from the line of credit and use it pay off part of the $135,000 table mortgage, leaving a balance of $115,000 to be fixed again for a period of, say, two years.

'Your line of credit will now be $24,000 owing, which leaves you an emergency fund of $6000 which can be drawn down if necessary. Now start the process all over again. Keep paying $1000 per fortnight into your line of credit. At the end of the next year, the second chunk of $135,000 will no longer be fixed and you can draw down funds from your line of credit to pay off part of it before fixing the rate again for two years.'

AGAINST

Does this all sound a bit like hard work?

If you are the type of person who prefers a hands-off approach to your finances, a revolving credit facility may not be right for you.

It can be hard to be disciplined about building up a balance in that account and the interest rates are higher.

Revolving credit facilities usually have a floating interest rate. At the moment, the median floating rate across the market is 5.89 per cent, compared to the less than 4 per cent available on several fixed terms.

If you had $50,000 on a revolving credit and never managed to lower that balance, you could end up behind where you would be if you had fixed the whole loan to be paid back over 25 years - and pay more for it.

You need to be honest with yourself about how you manage your money. If you're likely to spend everything you have available to you, or just want to set and forget, a revolving credit facility is probably not a good fit.

Are there any personal finance concepts you'd like explained or examined? Email susan.edmunds@stuff.co.nz