by Paul McBeth
Are revolving credit facilities a blessing or a bugbear?
Now offered by a swag of lenders, these mortgages are effectively large overdrafts at floating mortgage rates. They let you repay as much money as you like off your mortgage, but you're still able to redraw funds whenever you want.
Therefore, whenever you tip in extra cash you've reduced your daily outstanding balance and so trimmed back your overall interest bill.
The catch is you actually have to have that extra cash every now and then to get the benefit (there are generally extra fees associated with revolving mortgages). That's why they're often recommended for people who get paid on commission, whose income is "lumpy" or who have to set aside large sums for provisional tax. They can put that money to work reducing their mortgage interest bill, but still withdraw it when needed.
The risk? It can be major temptation: because you can draw out extra money whenever you want, there's the chance you don't end up reducing your overall borrowing. The other risk is your exposure to interest rate movements, as these mortgages are on a floating rate.
In a recent Mortgage Services newsletter, Forsyth Barr suggests you can reduce the interest rate risk by "hedging your bets". That is, you split the loan and have a fixed component funded from the revolving loan. You still have the flexibility to repay and redraw but part of your loan is locked into a fixed rate.
Forsyth Barr also points out the savings to be had by applying spare funds to your mortgage versus parking them in a savings account. Assuming your savings account earns 4.0 per cent (that's more like 2.68 per cent after tax, they say), and floating mortgage rates are averaging 8.56 per cent (which you're paying out of after-tax earnings). Forsyth Barr says "Instead of earning 2.68 per cent you are saving 8.56 per cent! To be better off saving, you would have to be earning around 12.78 per cent pre-tax".
Meanwhile, the Consumers' Institute warns that that revolving credit mortgages are a common tool of mortgage reduction agencies. It says these firms may encourage people to place their entire income on the facility, live off a credit card as much as possible and use the revolving credit facility to pay off the card in full each month just before interest is charged.
That should reduce your overall interest bill as well as save you fees, as you no longer use cheque and savings accounts. However, in an article on its web-site, the Institute cite some "big snags" with these schemes. One we've already covered and that's the temptation to keep borrowing.
However, the Institute says the biggest drawback (of using these schemes through mortgage reduction agencies) can be the fees. "The agencies typically charge thousands. Some even require their clients to pay a deposit before they investigate whether the client can save money. Yet you can sign up for very similar schemes with many banks and other mainstream lenders for a fraction of the cost."