A revolving credit mortgage works like a large overdraft or credit card, and mortgage advisers will often use a revolving credit as part of the overall mortgage.
Revolving credit is an account that is generally linked to a mortgage secured by property and allows you borrow money up to a maximum credit limit, pay it back over time and borrow again as needed. You get to use the credit over and over on a revolving basis.
When you set up a revolving credit account as part of your mortgage you be paying the floating mortgage interest rates which are generally higher than a fixed rate, and therefore you will select a credit limit that is not too big. Often the limit may be just $5,000 or $10,000 depending on your situation.
How Does Revolving Credit Work?
A revolving credit mortgage works like a large overdraft or credit card.
It means that you have access to money (within your credit limit) but only pay interest when you are using that money.
Like a revolving door, you can “revolve” your money in and out of the account and you only pay interest on what money you are using on any day. If you can pay off the balance in full then no interest will accrue from that date.
Many Kiwis love the flexibility that a revolving credit mortgage offers, but you need to be disciplined to get the most from these types of accounts – they are not for everyone.
Revolving Credit Got A Bad Reputation
When the banks first came out with revolving credit accounts there were some bad stories, where Kiwis were “sold” this new concept without really understanding how they worked.
There were people selling mortgage reduction schemes that were based on refinancing and using a revolving credit account to replace the traditional mortgage. Technically the schemes would work; however when you factored in human nature they only worked for the very few people that understood the way they worked and who were able to stick to a disciplined budget.
Too many Kiwis switched their mortgages to a single large revolving credit account and never managed to pay anything off. They got known as “revolting credit” by many people.
It was not really a fair reputation as a revolving credit account is a great type of loan; however there was never a need to have your whole mortgage on this type of account. Where the concept really works is to have a small revolving credit account, but the majority of your mortgage remains on fixed loans with the lower interest rates.
Selecting The Limit On Your Revolving Credit
As mentioned, the interest rate used is a floating interest rate and that means it will most likely be higher than a fixed rate and this is a good reason to select an appropriate limit.
But, with a revolving credit facility the interest that you pay is calculated daily on what is owning. If you only owe $1,000 on Monday then you are charged interest on that amount for that day, then you spend $400 on Tuesday meaning that you will have a balance owing of $1,400 on Tuesday and therefore be charged interest on the higher amount for that day. You might then pay off the $1,400 on Wednesday and therefore with a nil balance you will not be charged any interest for that day.
While the interest is calculated daily, in most cases the interest is charged monthly.
The aim is to have the revolving credit account limit set at an amount that you can manage. When thinking about the limit you should consider:
- If you want to have a backstop – you may want to have a few months of mortgage repayments in reserve so if you cannot work and earn for any reason then you have enough money set aside to ensure that you are not put under financial pressure. For many younger first home buyers this may be a good option if you plan to start a family, where you could drop to one income for a period of time. For self-employed this provides some protection should your business be seasonal or encounter a slow patch.
- If you want to pay your mortgage off faster – a revolving credit account allows you to increase your repayments to suit, and pay extra when suits. With a traditional floating home loan you may be able to pay extra, but many people will not put all of their spare money into it as they are not sure what the future holds and they may need to access the money again. By paying into a revolving credit you have the advantage of savings money (the interest otherwise paid) but also the ability to access the money again if needed or to change what you are paying.
- If you want to remain in control – with a standard home loan you may ask your bank to increase the repayments, but you then also have to ask the bank if you want to decrease them again. Your bank effectively has control and may not agree to decrease the repayments when you want or need them to as this may extend the loan term and therefore needs a new application to be submitted and approved.
Get Advice & Structure Your Home Loan
One of the most important roles of a mortgage adviser is to help structure the home loan.
Too often this is ignored, and people let the banks just arrange the home loan as one large loan. This is not efficient and is often just “lazy” by the banks who should know better.
But there is no incentive for the banks to show people how to pay off their mortgage faster, and in the process how to save money.
As mortgage advisers, the team at Mortgage Managers will help you structure your mortgage even if you already have a mortgage that was arranged elsewhere.
It’s a free service that we offer to ensure that you get the advice that you deserve.
