How can borrowers cut mortgage costs?

Amid rising interest rates and a higher cost of living, offset and revolving credit accounts can be  used to help people to save money, a mortgage adviser says.

Wellington-based Loan Market mortgage adviser Jo Vivian (pictured above) said that higher interest rates were a primary concern among her clients with mortgages rolling off lower fixed interest rates. Many were also feeling the pinch from the higher cost of living.

Offset and revolving credit accounts can help borrowers to save money on interest costs and set goals around repaying debt and saving, Vivian said.

Vivian, who has 20 years’ experience as a mortgage adviser, describes a revolving credit account to clients as a “big overdraft” than can be redrawn (although the goal is to pay it off over an agreed time).

A portion of lending is on a floating interest rate, meaning that the rate of interest is generally higher than a fixed rate loan.

Conversely, an offset account can be thought of as a “back to front revolving credit”, she said.  Multiple savings accounts can be linked to the offset loan account, the individual balances of each account reducing the interest charged on the loan balance.

Revolving credit accounts often work better for clients who are disciplined in managing their money, while offset accounts can be suitable for those who like transparency around their savings, she said.

Vivian spoke to NZ Adviser about the merits of each type of account and examples of how she is using them to help her mortgage clients.

Using revolving credit to reduce interest costs

With revolving credit, a portion of lending is on a floating interest rate, meaning that the rate of interest is generally higher than a fixed rate loan, Vivian said.

It can be used to operate as a main account, which has salary or wages paid into it, and expenses are withdrawn.

The idea is that clients pay as much as possible using their credit card, to keep funds sitting in the account, paying off the credit card balance before the due date so that no interest is incurred.

“Normally we do them as interest-only … as clients pay the debt down, they create a buffer that they can draw on again if they need to,” Vivian said.

As borrowers need to be strict about what they spend (as the full amount can be withdrawn), Vivian said that a revolving credit account worked well for a limited number of her clients.

“They can work really well for people who are good at managing their money … if [borrowers] aren’t really strict with their money, they often never end up getting paid down,” she said.

First home buyers unsure of the exact costs of setting up their home could consider using revolving credit as a way of holding additional funding in case costs run over.  Under this scenario, Vivian said that she worked out a client’s annual budget and from that, allocated a portion of the total loan to revolving credit.

“For example, if a client can pay off an additional $20,000 over a year, I’d put that on revolving credit and say ‘that’s your target’,” she said.

Fixed rate loans can be restructured to revolving credit when they roll over, setting a new target for a client to repay for the coming year, Vivian said.

Revolving credit accounts could also be used in situations where borrowers expect to receive a lump sum of money, such as a windfall, work bonus or pay rise in the short-term.

The amount of the incoming funds would be set up as a revolving credit, so that when the money is received, a borrower is not penalised for putting it against their mortgage, she said.

Using savings to reduce the loan balance

Distinct from a big overdraft (as with a revolving credit), Vivian said that the idea of an offset account was to break off a portion of the mortgage and set it up as a floating loan.

For example, where a client has a floating loan of $50,000 and combined savings of $25,000, clients are only paying interest on the $25,000.

Offset typically works for clients who need some help in managing their money, or who operate many different accounts (e.g. savings buckets) for different goals and like to see their savings grow, she said.

“Psychologically, some people like to see savings and for those people, it looks similar to what they’ve had,” Vivian said.

One drawback with offset is that the floating portion of the loan is not interest-only, meaning clients pay principal and interest regardless of how much money is in their savings account.

On the plus-side, it means that the loan can be repaid more quickly.

“If a client has $25,000 sitting in their offset account, they’re still making the same payments as they would if the entire balance (with offset) were at $50,000,” she said.

For mortgage borrowers who were struggling to meet their repayments and did not have spare funds to put towards repaying the mortgage or saving, Vivian said that there were a number of options, which should be assessed in line with personal finances and goals.

These options include pausing KiwiSaver contributions, pushing the loan term back out, moving to interest-only repayments, and possibly hardship, whereby mortgage repayments are paused for three to four months (noting that interest accrues).

While long-term fixed rates are currently attractive to borrowers, Vivian said that they should be wary of locking them in without talking to a mortgage adviser.  Due to break fees, there’s a risk that borrowers remain locked into higher repayments if interest rates fall.

Have you received positive results from using revolving credit and/or offset accounts? Share your thoughts in the comments section below.