Despite a cool housing market, property remains expensive. Currently, the average mortgage across New Zealand is around $360,000. Remember this is the national average. For buyers in Auckland, Wellington and other property hotspots, you can expect much larger mortgages.
And with a large mortgage comes a large interest bill. If you take out an average mortgage of $360,000 on a 25-year term, at the current average one-year fixed rate on Canstar’s mortgage database of 7%, you will pay around $16,000 per year in interest over the life of the loan, or $403,000 in total interest payable (NB: assuming a 7% rate over the entire 25-year term).
So, in order to bring down your interest charges, and to pay off the mortgage faster, two options to explore are offset mortgages and revolving credit accounts.
While these may not work for everyone, they can give you the flexibility to manage your mortgage better, and help bring down some of the costs involved.
But which is better: an offset mortgage or a revolving credit account?
What is an offset mortgage?
An offset mortgage uses the money in your bank accounts to bring down the interest payments on your mortgage. With an offset mortgage, you are not charged interest on the full amount of your mortgage. Rather, on your mortgage, minus any money in your designated offset accounts.
For example, if you have a mortgage of $550,000 you would normally be charged interest on this full amount. However, with an offset mortgage, if you have $30,000 in one account and $5000 in another, these would be subtracted from your mortgage before interest is charged. In this example, you would only be charged interest on $515,000.
It’s important to note that the balance in your offset accounts do not pay off the principal loan, they simply reduce the interest on it. So, you will still need to set aside money to make regular mortgage repayments.
Why get an offset mortgage?
Savings accounts tend to earn very little interest. Because of this, money kept in a savings account is secure, but it isn’t being used to your full advantage. It doesn’t grow your savings or reduce your debts.
With an offset account, however, your savings are reducing your debt while still being accessible for you to use. Instead of your savings accruing minute amounts of interest (often below the rate of inflation), it will be used to reduce your interest repayments.
You can also be flexible with an offset mortgage. You can make as many lump-sum repayments towards your mortgage as you like, and have greater flexibility about the size of your regular repayments.
Any spare money you have can either be put into your offset account (reducing interest) or paid as a lump sum onto your mortgage (reducing the principal).
What are the downsides?
Offset mortgages come with floating interest rates, which are usually higher than those on fixed-term mortgages. Floating rates also fluctuate with the market. So, if you want certainty around your payments, this may not be a good option.
Additionally, offset mortgages do not allow you to redraw. While the money in your offset accounts is free for you to access, any money you use to pay off your principal cannot be taken back. So, if you make a lump-sum repayment, only to then receive an unexpected bill, you can’t get that money back.
What is a revolving credit account?
A revolving credit account is like an account with a large overdraft facility. Interest is calculated daily on the balance of the account, so any money you put in (such as your savings and salary) reduces the loan, thus reducing the interest payments. But, any money you take out (bills and daily expenses) will bring the balance back up and increase the interest repayments.
With a revolving credit account, you can essentially put all your money towards repaying your loan while still having the ability to take that money back whenever needed.
Why get a revolving credit account?
The biggest benefit of a revolving credit account is your ability to put all your money towards your mortgage, while still having full access to it. Instead of paying back a loan little by little, you can put all your money into it. But, should you need to, you can take back any of that money at any time. As long as you continue putting in more money than you take out, your loan will continue to decrease.
If you have a lot of savings, or a high salary, this could help you pay off your mortgage a lot faster than simply making fixed repayments. Especially as most mortgages have repayment schedules that don’t allow you to make lump-sum payments.
So, if you receive a large bonus from work, you could put it all towards your mortgage, unlike a fixed-rate mortgage, which wouldn’t allow a large lump sum payment (without incurring a high fee).
This type of mortgage could also be a good option if you have an irregular income, for example, if you’re self-employed. When your income is high you can pile all your money into the account, but during periods when you may be earning less, you have the ability to redraw that money freely. All your money goes towards your mortgage, without locking it away.
What are the downsides?
The biggest downside for many is that a revolving credit account can be hard to manage. By putting all your finances in one account it can be hard to keep on top of how much is going in and how much is coming out. Your mortgage is now your savings account, which is also now your everyday spending account.
You have to be good with your budgeting and on top of your finances if you want to consider this option.
You also have to be strict about your spending. For some, it may be too tempting to redraw funds to make unnecessary purchases. Having full access to redraw your repayments is helpful when unexpected costs arise, but not if you treat it like a credit card.
Additionally, like an offset mortgage, a revolving credit account is on a floating rate, which is usually higher than a fixed-term rate. While you have the benefit of being able to pay off lump sums (which would often incur fees on a standard mortgage facility) you do so at a higher interest rate.
Offset mortgage vs. revolving credit account: which is better?
Both offset mortgages and revolving credit accounts have a lot in common. They both work by using your savings to bring down your interest payments. However, offset mortgages have some definite benefits. The fact that you don’t have to pool all your money into one account allows you to keep your finances separate, which can be easier to manage.
Plus you can link multiple accounts, for example your tax or GST account. And some banks even let you offset other family members’ accounts, which could be mutually beneficial.
Just keep in mind that offset accounts do not accrue interest.
However, while every bank has a form of revolving credit home loan, not all banks have offset mortgage options. So depending on who your lender is, it may not be an option for you.
Furthermore, whether or not you are eligible for one of these mortgage options is up to your lender. They may have certain criteria you need to meet in order to be eligible.
Should I get an offset mortgage or a revolving credit account?
With both offset accounts and revolving credit accounts, you are subject to floating interest rates. This means your interest repayments can fluctuate, and you won’t have certainty around your repayment sums. If you are on a tight budget, certainty around how much you have to pay each payment cycle is likely more valuable to you than offsetting interest.
Additionally, if you drained your savings account for your deposit, how much are you actually going to be able to offset? If your mortgage is in the hundreds of thousands, putting a few thousand into a revolving credit account isn’t going to make much of a dent.
For example, 3% interest p.a. on a $200,000 loan comes to $6000. If you then put $5000 into your revolving credit account, 3% p.a. on $195,000 comes to $5850.
Here, your $5000 in offset barely makes a dent. Unless you have a substantial amount of savings or a high salary that can increase your balance quickly, it may not be of much benefit.
You don’t need to put all your eggs in one basket
Remember, you can always choose to divvy up your mortgage. Many people don’t put their entire mortgage on one payment term. Many will divide it up, putting a portion on a floating rate, and other portions on fixed rates of differing lengths.
An offset mortgage or a revolving credit account is no different. You can always put a portion of your mortgage into one of these while putting other portions onto fixed terms. This will help give some certainty, as well as reduce the impact of interest rate changes.
It’s about finding what works best for you.
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This report was written by Canstar Content Producer, Caitlin Bingham. Caitlin is an experienced writer whose passion for creativity led her to study communication and journalism. She began her career freelancing as a content writer, before joining the Canstar team.