As interest rates rise and the cost of living increases, you aren’t alone in looking for ways to save money. Being smart in how your loan is structured can help you save costs and pay your mortgage off faster. In this issue, we focus on one such product our advisers often recommend, Revolving Credit.
Revolving Credit is often the least understood and sometimes most under rated homeloan product on the market. It’s the most flexible of home loan products and operates like a big overdraft, but at floating housing rates.
How does it work?
A credit limit is elected at the outset, and you can draw up to this limit at any time. There are no regular required payments to the account, but you can at any stage tip funds in without penalty and these funds are available for you to access at any time. The real major difference between a revolving credit homeloan and a standard floating homeloan is that revolving credit can have an EFTPOS or Debit card linked, meaning any money you apply to the account can be readily accessed as and when required.
As soon as any funds are transferred into the account, your owing balance reduces. As such you are charged less interest on your mortgage as the balance drawn on your revolving credit is less. Effectively any funds you do apply to the account automatically offset your interest cost. For example, if you started with a $25,000 revolving credit limit and on day one you tipped $10,000 cash into this account, the Bank would charge you monthly interest on the $15,000 owing balance only. The $10,000 cash tipped in is freely available (for any expenses that arise but does its bit by offsetting $10,000 worth of mortgage interest cost in the meantime).
How is interest calculated?
The banks calculate interest daily and charge it monthly to these accounts and as such, as soon as any new funds are added to the account, they immediately offset your monthly interest bill. This is why we typically recommend having your salary credited directly to the account – each pay day you will see your owing balance reduce and save on interest.
Tips to get the most out of your revolving credit
Use your credit card to take advantage of the interest free period attached to it. Consider putting all your everyday expenses such as groceries, fuel, power etc directly on to your credit card. Here you collect reward points on your expenditure and your card will have an interest free period attached. Ensure that your card is linked to directly debit and clears itself monthly from your revolving credit account and this will mean you’ll pay zero interest on your credit card, you’ll collect rewards points and all of your household bill costs will have spent the month offsetting your mortgage interest bill.
Consider running your revolving credit account as a joint savings and transactional account. If you look at the low rates of interest Banks pay on savings accounts – currently somewhere close to 4-5% which then gets taxed, meaning you might end up with a net return close to 3%. If you save directly into your mortgage, you’ll instead receive a net mortgage rate of return on your savings which currently sits close to 6.50%.
Example
Purchase Price: $800,000
Deposit: $175,000
Required Mortgage: $625,000
Here you might take $25,000 as a revolving account and $600,000 locked as fixed rate loans - perhaps splitting $300,000 for 12m and $300,000 for 36m to provide interest rate hedging as follows:
LOAN 1: $25,000 Revolving Credit (interest charged on drawn balance only) This forming the funding account for the two fixed loans, ie the interest payments for loans 2 and 3 below are paid out of this account.
LOAN 2: $300,000 Fixed 12m
LOAN 3: $300,000 Fixed 36m
On settlement, the bank would pay a cash contribution (currently around 1% of the loan) so in this example, $6,250 would tip into the Revolving Credit account providing an immediate buffer and offsetting interest cost.
We recommend repayments for the fixed loans are paid from the Revolving Credit account, and salary is credited to the same (Revolving Credit) account.
A Revolving Credit account gives you the flexibility to pay your mortgage off faster; the goal in this example would be to pay the revolving credit balance off in full before the 12 month fixed loan rolls and then take a further 25,000 from that loan to top up the revolving credit account and repeat the same process.
Helping our clients secure smart loan options is important to us, if you would like to learn more about Revolving Credit or review your plan to pay your mortgage off faster, get in touch with the team. We are here to help.