What is a revolving credit mortgage?
A Revolving Credit Mortgage allows you the flexibility to use the equity you have built up in your home for a wide range of investments or purchases. A revolving credit home loan is like a large overdraft secured against residential property. It operates as a current account, with interest accruing daily on the outstanding balance. And, because they are residentially secure, you get a low home loan rate on these borrowings (certainly lower than a personal loan).
How does a line of credit work?
Say you borrow $300,000 from a bank to buy a home, with a deposit of $50,000. That means that at that point, your equity in the home is $50,000. Ten years later, your debt is down to $170,000 and your property has increased in value to $450,000. This means that all up, you now have around $280,000 equity in your home. Provided you meet the lending criteria of the financial institution, you may then be able to take out a loan against a proportion of the equity you have.
The most common type of home equity loan is the line of credit, which functions in a similar way to a credit card. You have a pre-approved credit limit and you can borrow as much of this sum as you want, with interest paid on the outstanding balance.
Benefits of Revolving Credit Mortgages
|Access funds easily, with most revolving credit facilities offering cheque books, plastic cards, internet and phone banking and a range of transactions and you can withdraw up to your credit limit at any time.|
|Use the available funds in your revolving credit facility to consolidate debts such as credit card or car loan usually at a much lower interest rate – although there is a danger here that, despite minimizing your monthly repayments, you might end up paying off the debt over a much longer term, costing you more in the long run. Fortunately, this can be avoided by paying more than the minimum each month.|
|Reduce your overall monthly repayments by consolidating your debts into a low rate credit facility.|
|Minimise your monthly interest charges by depositing all of your income into the account and withdrawing as you need it.|
A Revolving Credit Facility offers flexibility
When used correctly, Revolving Credit mortgages offer flexibility and can have some great benefits for those that are disciplined enough to use them to their advantage. For example, if a borrower deposits their salary into the account they will be reducing the interest that is accruing while that balance is maintained. The overdraft slowly increases again over the month as money is withdrawn for day-to-day living expenses. While it doesn’t sound much, think about how many paydays there are in a typical 25 or 30 year home loan.
Even a small reduction in interest each month can add up to a substantial amount over time.
When used for borrowing, these facilities allow you to substantially reduce the interest you might otherwise pay on a standalone loan. For example, on a car loan, the typical interest rate might be 14%, however using your revolving credit facility you can get the loan for around 6%.
This is a substantial saving and one that anyone can obtain.
Budgeting essential with Revolving Credit Mortgages
The risk with these products occurs when the borrower is ill-disciplined and does not adjust their budget to cater for these new borrowings. For example, if you do use a revolving credit facility to buy a car, make sure you increase your repayments for a similar term to a car loan to pay off the extra debt. A car loan would typically be paid off in say three to five years, so increase your repayments to the revolving credit facility for that amount of time. This will ensure that you do save on interest.
The biggest trap for many people is not to increase the repayments. Over 25 years, for example, a $15,000 car loan at 6% will cost a total of $28,993.56. Paid off over five years on a car loan of 14%, the total amount paid would be $20,941.43. It’s actually cheaper to get the more expensive car loan! Check out the line of credit case study in this article for more information.
Benefits aplenty for the disciplined
However, if you are disciplined and pay off the amount over 5 years at 6%, it would cost you a total of $17,399.52! So revolving credit is a fabulous product in the right hands.
While a revolving credit facility can be a great way to borrow, an added benefit is that savings made into your revolving credit account return the same as the mortgage interest rate, say 6%. It works because you’re paying that much less interest on your mortgage, and its tax free.