Nothing seems more certain than rising home loan interest rates in 2014, especially floating rates.
That is because the RBNZ has given clear 'forward guidance' that it has started the process of normalising interest rates away from the stimulus settings needed to combat the GFC and the Christchurch earthquake.
Our economy is doing well at present and it is time to revert to a more realistic cost of money.
Cheap money causes people to make distorted decisions.
Home owners with a mortgage now face new choices and options.
Many are choosing to switch away from floating rate loans, locking in the certainty of fixed rates "before they rise even further", following market signals that the OCR could be as much as 1% higher by the end of 2014, and possibly another 1% higher by the end of 2015. Nothing about the future can be said for certain, however.
But is switching from floating (or short term fixed) to long term fixed the right move?
I can't tell you; that is a decision you will have to make based on your own personal financial situation and your tolerance for risk. You should seriously consider getting the advice of a professional adviser if you are unclear about any aspect of a decision. Over a long period, financial variances can add up to a lot.
For some people, staying with a variable rate will make sense, however.
And this will be the case, even if the interest rate for variable rates is higher than floating rates.
It's not all about the rate.
It's actually about the rate you pay your loan off. Most people overlook this crucial fact, but the maths are clear.
For many people who can maintain sensible financial discipline over a long period of time, floating rate arrangements will result in paying less interest over the lifetime of the mortgage and consequently less total payments. You end up getting your house for thousands less.
And that is because floating rate mortgages allow you to make extra pay-downs in a way that fixed rate ones don't.
For most people, the best way to achieve this is by using a revolving credit account.
Revolving credit is more like a giant overdraft arrangement than a standard mortgage loan.
In a standard table mortgage loan, you make equal payments regularly that pay off the loan in a fixed period of time (25 years, say). Yes, you can fiddle with it by making extra drawdowns and banks will love you for doing that. Or you can make the occasional extra payment when you have additional funds - when the loan allows it.
But a Revolving Credit loan is smarter than that. It allows you to get these advantages from the weekly irregularities of your bank account.
This is how it works:
The bank converts your mortgage to an Revolving Credit account. In fact, this is your current account with an overdraft level equal to what you owe them on the home loan.
Into this current account (it used to be called a chequing account) you credit your pay, and pay out your expenses.
The overdraft limit reduces by the same amount as your previous mortgage payment - so the amount of overdraft steadily decreases over time.
But here's the big benefit: any and every balance below that limit saves you interest. Interest is only charged by the bank on what your account balance is, not what the Revolving Credit limit is.
So when you have your wages or salaries (or bonuses, or proceeds from your Trade Me sales, or inheritances from a great aunt, or whatever) paid into your current account, that reduces the interest you pay. Sure you will buy groceries, petrol, pay insurance etc out of that account and these transactions add to our overdraft. But unless you are running insolvent - buying more than you earn - you will get the long-run benefit of the gap between your actual bank account and the Revolving Credit limit.
This chart shows you the principle.
Another advantage is that these small benefits are calculated on a daily basis, so every day you are below your limit is an interest-rate saving benefit to you. Keep that up and you will pay off the home loan faster than just staying on the table mortgage treadmill for 25 years.
And it can be much faster.
The numbers can be astounding. A trusted professional mortgage adviser can work them out for you, or you can use our handy mortgage calculator to get a sense of what they may be. It's a little fiddly to do on your own, but if you are good with spreadsheets, its worth a try.
The savings are real. If you don't make them, they just get paid to the bank.
However, there is a catch. To get these benefits involves 'work'.
You need to be focused and disciplined over a long period to 'earn' the $10,000s that will be involved for most people.
If you don't work at it, you could get into a financial hard place. That difference between the balance in your revolving credit account and the account limit can be drawn on at any time. There is a high temptation sitting there - and the bank wants you to spend it. They earn their best interest off you if you run a revolving credit account to its maximum. The holiday in Fiji, the new car, the new TV or gadget will be whispering in your ear "you can afford it" - and as the separating builds up it will look like you can 'afford' bigger and bigger things - often things like remodeling projects.
A revolving credit account can act just like an ATM. And that is the trap. (In fact, credit cards and revolving credit operating together can be double trouble for the weak.)
If you can avoid the temptation however, you win big; over 25 years, really big. Your home loan could be paid off many years faster and the savings are enormous.
And a few extra basis points interest you will pay on the arrangement will be chicken-feed, almost irrelevant compared with the benefits.
Do you have what it takes? Only you know that, but an experienced professional mortgage adviser you trust will be able to quantify what you stand to gain.
| Plan |
Monthly $ Fee |
Current % rate |
|
 |
Flexible | 12.50 | 6.10% |
 |
Orbit | 12.00 | 6.00% |
 |
Mortgage One | 20.00 | 6.60% |
| Rapid Repay | 3.50 | 6.19% | |
| Kiwibank | Revolving | 0.00 | 5.90% |
 |
Choices Everyday | 9.95 | 6.00% |
| Co-op Bank | Revolving | 7.50 | 5.95% |
 |
Home Equity | 0.00 | 6.60% |
 |
Flexi | 0.00 | 5.90% |
| TSB | Liberty | 10.00 | 6.04% |
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Mortgage choices involve making a significant financial decision so it often pays to get professional advice. A Roost mortgage broker can be contacted by following this link »
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29 Comments
We also found them really good given we moved house frequently as we didn't need to re-sign/draw up new loan agreements - the security on the existing mortgage (i.e. revolving credit/overdraft) just changed to the new place ... no additional lawyers fees involved.
Do changes in the interest rate charged on revolving credit accounts reflect changes in floating rates? I am considering switching to a revolving credit account but am a bit reluctant to do so if the interest charged on revolving credit accounts will rise with OCR changes.
Genreally yes the revolving credit rate will follow the OCR up and down, same as the floating rates. Every bank is different and the exact timing of rate changes will vary from one product to the next, but in the end the rate will move up and down.
Fixed gives you more certainty, but if you are disciplined the reduced interest payments will save you money in the long run.
I may be very wrong but here i go.If i han 50k sitting dormant in the bank,also had a 50k mortgage with the same bank would i be paying any interest on the mortgage under a revolving credit scheme.I am presuming that the amount of interest paid on the 50k bank account would be nothing and the mortgage interest would be nothing.I don't really know.
To clarify a bit. Revolving credit and offset mortagages are very similar products that look very different.
With an offset mortgage you keep your mortgage and savings in seperate accounts. You earn no interest on your savings, but it is deduced from your mortgage when they caclulate your mortgage interest.
With revolving credit, you woudn't keep the savings in a seperate account. You would just have one account for current, savings, and mortgage. You would your savings in this account, and it would reduce the balance of your mortgage, and hence your interest payments. When you need your savings you simply withdraw from the account which will increase your mortgage balance.
As far as i can tell, they are effectively the same.
A revolving credit facility sounds wonderful and they can be but mostly they aren't. That is why the Banks reccomend them. Very very few people today are financially disciplined enough to use them in the way you reccomend David. Society is organised for them not to be. Most people who have them end up in greater debt than when they started. An ordinary mortgage provides that discipline and a person can always make their payments more for that fixed rate period in order to reduce their overall interest payments.
I am certainly not 'recommending them' - only explaining how they work.
No-one should blindly go into one. That is why I say review with a professional adviser first.
The pitfalls (which I listed) can be fierce for the undisciplined. I suspect many people who get into trouble with them started out with little or no research and no professional advice or aseessment as to their suitability.
Not necessarily. The default of a revolving credit facility is that the limit remains at whatever you decided initially.
With this type of facility you want a reducing limit in line with your term. So that, worst case scenario you can still pay off the loan and be debt free within your original term. As David highlights it is not for everyone and it requires a plan, a way to monitor how you are tracking against this plan and regular reviews.
A good idea that we have contemplated. But, almost all rural lending is like business lending and as such is 'risk priced'. There are no carded rural rates at all, that we know about. It all depends on how the bank sees your business, through the filter of your financial accounts.
We are trying to give some more exposure to business lending, especially business overdrafts. Try this page and this tool.
Would be glad to hear of any ideas to cover rural or business lending rates.
And as dtcarter explained above, if you do it as an offset, then you get both the benefit and the discipline, as any money you are spending is your own, and especially if you don't have an overdraft, you will still be spending less than you earn. Debt is so easy.... just borrow for appreciating assets.... viola!
One of the best ways to use revolving credit is to only ask say for $25 to $100k then basically you would have to earn more than that each month for it not be effective. In other words make this your day to day account and then if you earn (your partner & rent as well) into the same account you will get the $5-20k buffer each month of savings. Net you are talking about saving say $500-1000 a year in interest (minus monthly bank charges) In the long run it will help a bit like the Kiwisaver tax deduction....it all adds up! Plus if you get a windfall (bonus / granny) then you can put that $50k into your home loan or whats left; E.g.Remember most banks let you pay of 5% of your home loan each year with no penalty. Again everything helps!
The problem with Floating or Revolving currently is the interest rate gap between floating at 6.2. and fixed at 4.35. That's a lot of interest to pay for flexibility. If you have savings best to wait until fixed period is over, briefly float while repay into mortgage from savings, then refix again,
How the rates have dropped since this - currently as low as 3.45% per https://www.moneyhub.co.nz/revolving-credit-mortgages.html (Kiwibank). Arguably, revolving mortgage facilities can still work out to be more expensive for short-term purchases if those repayments drag out...
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