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Is Revolving Credit Beneficial Or Is The “Instant Credit” Just a Carrot?

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Contributor:
Brian Dalley
Brian Dalley

From “The Little Black Book” Series.

Revolving credit facilities are more than just a low cost overdraught facility.

They can be and are the most basic of financial tools. However as a certain level of budgeting and self-control is involved to capitalise on the principle saving money many first get tempted by the carrot - spending money.

A revolving loan can save thousands of dollars in interest and help you be mortgage free years quicker, as long as you manage it carefully.

Sitting down with a young couple recently discussing their second purchase, a number of misconceptions surfaced. The meeting went for over two hours, my words here are limited so I will be brief and summarise

This was Scott and Karen’s wish list;

They would like to hold back $15,000 for emergencies; Scott’s Mum isn’t getting any younger and is living in London.

They also wanted to save and make lump sum payments at will,

In saying that, would also like to feel protected against possible rate hikes by fixing a proportion of the loan.

After discussing day-to-day budgets, term goals and lifestyle, we decided split the loan into three parts and the following structure was put in place with a recommendation that it be reviewed in twelve months.

The First Part

$30,000 on a revolving credit facility

$15,000 of the $30,000 would be immediate credit, yes essentially they were going to create a loan for $30,000 and repay $15,000. However at any stage they would have access to the $15,000 but would only start paying interest on it when drawn on. [Interest rate 5.65%]

The alternative would be to leave the $15,000 in the bank - [Kiwibank online call 3.25%].

What in fact you would be doing then is investing the money with the bank in return for 3.25% interest, less tax and in return they would loan it back to you at 5.65% as your mortgage would be $15,000 more if you had the $15,000 in savings rather than reducing your mortgage. Unbelievably it does happen.

The second $15,000 was the amount Scott and Karen were sure they could save each year and make a lump sum payment. They did not want to increase the payments as it was only a few months and Karen would be on maternity leave and again wanted to err on the side of caution. In this way they can make loan payments in line with their lifestyle and without the pressure of an increase being a condition

The Second Part

The second loan we fixed for a period of 12 months

Which if all goes to plan, on expiry, they will transfer part of the loan balance to the revolving credit facility as the first $15,000 should have been repaid by then and keep chipping away at the mortgage.

In essence they were creating a safety net, [insurance] chipping away at the mortgage, reducing debt and if things went wrong they could extend the remaining mortgage over the loan term, which would reduce the payments required to service the mortgage.

Many are afraid to commit extra to a mortgage as recently it has been reported that some lenders are reluctant to allow the borrowers to re-draw on the buffer. In reality, that generally relates to lump sum payments.

The Third Part

The third part we fixed for a period of three years.

This decision was based largely on market predications over the medium term.

Although a revolving credit facility is the most affordable instant credit facility, on the market, it should be viewed in the same light as credit cards and overdraughts, short-term solutions that should be repaid at the earliest opportunity.

If you already have a revolving credit facility and you are not managing to reduce the loan amount, it may pay to take a closer look at what is going on.

For now you should be OK as it is one of the lower rates but as they increase you may find yourself loosing money quickly.

Did you know you could split your mortgage in a number of ways? Subscribe to this feed or keep an eye out for further posts from “The Little Black Book” series…

Brian Dalley is a leading NZ Property Consultant | former NZMBA Mortgage Broker, and Real Estate Agent.  You can read more of his views and opinions on his website www.propertyprofit.co.nz.

 

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