Maximising mortgage savings: understanding offset mortgages and revolving credit loans

Mortgages should not just be set and forget. Times change, circumstances change and bank policies change. That’s why we’re here. Our job is to help homeowners optimise their mortgage arrangements so they can get rid of debt faster. But for that to happen, mortgage holders need to have the right home loan fit and more importantly, they need to fully understand the ins and outs of that mortgage product.

To quote Aseem Agarwal, Head of Mortgages at Global Finance, “Knowing the product is one thing, using the product is another. Only by knowing that the product is right for you, and how to use it, can you then reach your destination. It’s no different to: “I have a car, but I don’t know how to drive”. Unless you have a car and also know how to drive, you won’t reach your destination. Just having the car itself doesn’t mean that you will get there”.

Offset mortgages and revolving credit loans

Two popular types of mortgages available are offset mortgages and revolving credit loans. While both can potentially reduce the cost of a mortgage, they differ in their structure, repayment options, and flexibility. And you need to proactively manage both of them.

Basically, an offset mortgage uses savings to mitigate mortgage interest payments. It takes the positive balance in your savings account and deducts it from the balance of your mortgage. You then only pay interest on the difference between the two.

Revolving credit loans have a single account where you deposit all of your income and from where you pay all your bills and mortgage payments. It’s like a big overdraft facility. With daily calculated interest, you reduce interest you pay by having accumulated cash that offsets the loan.

Just walk away …. not

“Often banks and advisors advertise that if you offset your loan with your income and savings, you can use those savings to against your home loan”, which Aseem says this is essentially correct. However, he adds that customers can be led to believe that this mortgage arrangement “will magically just make their loan disappear”, and this is what concerns him.

Unlike traditional mortgages, which have predefined repayment schedules, homeowners must proactively instruct the bank to make lump sum payments from their revolving credit or offset accounts towards the mortgage principal. This is not a set and forget situation.

For these mortgages to work in your favour, you need to “take action and you’ve got to instruct the banks”. Aseem wants to dispel the myth that “you can take out a loan and separate it out into a fixed lump and revolving and it’s automatically going to work magically for you”. You have to make the bank transfer sums; it will not do that automatically.

An offset mortgage – how it works

Rather than putting your mortgage and savings into one account, as with a revolving credit that has money coming in and going out, an offset mortgage keeps two, or more, accounts separate but linked. You have a loan account where your mortgage is on a floating rate and an offset account (or accounts) you put money into.

The savings you have in an offset account, reduce, or offset, the interest you pay on your mortgage. Instead of earning interest on your savings, the balance in your offset account(s) reduces the amount of interest you owe on your mortgage.

For example, if you have a mortgage of $300,000 and savings of $50,000 in your linked account, you’ll only pay interest on $250,000 ($300,000 – $50,000).

Generally, interest saved from offsetting a home loan outweighs any interest you might have earned in a savings account and by paying less interest, a bigger portion of each mortgage repayment can go towards repaying the principal.

Even small balances in your linked accounts can have an impact on the amount of interest you pay and can result in significant interest savings over the life of your mortgage.

However, your savings won’t actually bring down the capital of your loan unless you tell the bank to physically transfer it to your loan as a lump repayment. And paying down the capital is where the real savings lie.

Flexibility and access

Offset mortgages are flexible. They offer the freedom to deposit and withdraw funds from your savings accounts as needed for things like emergencies, holidays, a new car or even investment opportunities. Savings are accessible while still lowering mortgage interest payments.

But, you need to actively manage your accounts and make strategic lump sum payments towards your mortgage principal.

Revolving credit loans

This type of mortgage typically has interest-only payments calculated on a daily basis and repaid at the end of the month. Alongside making minimum mortgage repayments, you can use spare cash to make lump-sum payments off your mortgage. For example, maybe you can save an extra $300 away a week which adds up to just over $15,000 a year. At the end of the year, when you have saved that amount, (because you are paying less in interest) you can put this entire amount back into your main mortgage.

But again, “Once you have saved the funds to pay off some of the loan, you have got to instruct the bank to then reduce your loan”, Aseem reminds us. It is not automatic. A non-reducing revolving credit is like an interest-only loan, where the size never decreases unless you tell the bank to do so.

Not all revolving credit loans are created equal

Very importantly, some banks do offer a principal and interest revolving credit mortgage. This mortgage is more like a traditional loan where you pay both the principal and interest off over 30 years, for example. However, unless you know you have this type of payment plan on your revolving credit, you potentially won’t be on the best mortgage deal you could be.

There are multiple ways to structure a mortgage

For homeowners to get the best mortgage fit they can, they must understand the mortgage products available. The best way to do that is to have a conversation with a mortgage broker. We can put you in control of your mortgage repayments.

Is an offset or revolving credit mortgage the best fit for you?

Our mortgage brokers can look at your lifestyle, income and ascertain whether you’re the type of person who likes to have separate savings accounts for things such as holidays, education, home maintenance or whether you prefer to keep to a strict budget. We can advise you on the right structure for your loan so you can live the life you want.

Our experienced team can also provide ongoing support and regular reviews to ensure you are on the best path to paying down your mortgage as fast as possible. So, if you’re looking for experienced, qualified financial advice and guidance, get in touch with the team at Global Finance on 09 255 5500 or info@globalfinance.co.nz

The information and articles published are true to the best of the Global Finance Services Ltd knowledge. Since the information provided in this blog is of general nature and is not intended to be personalized financial advice. We encourage you to seek Financial advice which is personalized depending on your needs, goals, and circumstances before making any financial decision. No person or persons who rely directly or indirectly upon information contained in this article may hold Global Financial Services Ltd or its employees liable.