Offset Mortgage vs Revolving Credit Mortgage - What's the Difference?

Offset and revolving credit mortgages are two different types of loans with their own unique benefits and drawbacks.

An offset mortgage allows you to use savings and funds in your transactional accounts to offset the interest on your loan, which can help you to pay down your mortgage faster. Revolving Credit, on the other hand, is a line of credit that allows you to borrow up to a certain amount and pay it back over time. In this blog, I’ll aim to demystify the concept of offset and revolving credit mortgages, how they work, and who they are best suited for.

How An Offset Mortgage Works

With an offset mortgage the borrower's savings and transactional accounts are linked to the mortgage. The money in the linked account helps to 'offset' the mortgage balance, thereby reducing the amount of interest charged.

Let's take an example. If you have an offset mortgage with a $550,000 balance and $50,000 in a linked accounts, you will only pay interest on $500,000. This means, the more you save and the longer funds stay in these accounts the less interest you will pay. Typically, you forgo the ability to earn any interest on the money in an account linked to an offset mortgage but since the interest you are paying on the offset mortgage is usually higher than what you could earn in a savings account it's worth it.

Multiple Accounts and Offset Mortgages

It's not uncommon for borrowers to link multiple accounts to their offset mortgage. These accounts must be with the same bank as your offset mortgage facility. You can even link family members accounts to your offset mortgage, (with their permission of course!) further helping you to reduce the interest cost on your loan.

Interest Rates on Offset Mortgages

Offset mortgages usually have a variable or floating interest rate which is typically higher than fixed interest rates. Therefore, it pays to offset as much of your mortgage as you can. Many borrowers choose to split their loan between an offset mortgage and a fixed interest rate mortgage for maximum benefit.

Repayments

With an offset mortgage, you make regular fortnightly or monthly repayments towards the interest and principal on the loan. As the variable interest rate fluctuates, your regular minimum repayments can increase or decrease. Since it has a variable rate, you also have the flexibility to make lump sum repayments to an offset mortgage whenever you wish. These repayments reduce the amount owing and the interest charged, helping you repay the mortgage even quicker and reduce the overall interest paid.

Who would benefit from an Offset Mortgage?

Offset mortgages can be a good choice for those with savings they expect to keep for some time. For instance, people with an emergency fund can use it to save interest costs and become mortgage-free sooner.

Drawbacks of Offset Mortgages

However, offset mortgages may not be a good idea for people who are tempted to spend their savings. The interest charged on an offset mortgage is higher than a fixed interest mortgage, so spending some of the offsetting savings can be expensive. Another point to note is that currently there are only three banks in New Zealand who offer offset mortgages and they all have slightly different criteria, so it pays to work with a Mortgage Adviser to guide you in this area.

Understanding a Revolving Credit Mortgage

Revolving credit mortgages are like all-in-one bank accounts with a large overdraft limit and offer a flexible approach to lending. With a revolving credit mortgage, you have the freedom to draw down a loan, deposit funds, and withdraw money at your own pace, as long as you do not surpass your borrowing limit. A revolving credit mortgage operates on a variable or floating interest rate, which means it fluctuates with market rates. Some banks may offer a special rate or discount on a revolving credit facility so it's always best to talk to a Mortgage Adviser to find out what's available.

The Discipline Required for a Revolving Credit Mortgage

To utilise a revolving credit mortgage effectively, you need a high level of financial discipline. The freedom to spend can easily lead to a spending spree, which can delay paying off your loan and increase your regular interest payments. However, for those who are disciplined with money, a revolving credit mortgage can function as a highly effective savings account. If you deposit your savings into a revolving credit mortgage account, it helps to reduce the loan balance thus reducing the amount of interest you pay. It's best to seek advice before signing up for this type of loan. A Mortgage Adviser can provide invaluable insight into whether this financial product aligns with your financial goals and lifestyle.

How is the Interest Calculated on a Revolving Credit Mortgage?

As interest is calculated daily based on your account balance at the time, any funds you deposit into your revolving credit account will decrease the daily loan balance, thus reducing the interest you pay. This system also offers the advantage of using your income to lessen the loan balance temporarily, which can result in significant interest savings.

The Use of a Credit Card with a Revolving Credit Mortgage

A smart strategy for maximising the benefits of a revolving credit mortgage is to use a credit card for most purchases and pay it off in full from the revolving credit each month. This tactic helps maintain a lower loan balance for a longer duration, thereby reducing the interest paid.

Fixed Limit or Decreasing Limit?

Most lenders offer revolving credit mortgages with either a fixed or steadily decreasing limit. Both options provide the same convenience and flexibility, but a decreasing limit offers a safety net. It ensures a steady reduction in your debt, decreasing your regular interest payments and helping you become mortgage-free within your planned timeline.

Who Would Benefit from a Revolving Credit Mortgage?

Revolving credit mortgages can be an excellent fit for those that have an irregular income like freelancers, contractors, and seasonal workers. This mortgage type can help smooth out the cash flow highs and lows. It allows you to use the money you earn to reduce your debt, which in turn reduces the interest charges.

What Are the Other Uses for a Revolving Credit Mortgage?

A revolving credit mortgage allows you to borrow up to your agreed limit whenever you want. One major advantage it has over other loans is the interest rate. You'll only be charged the variable mortgage rate, which is often much less than you'd pay for a personal loan or hire purchase.  Another handy use is if you're planning to save up for renovations or home improvements, a revolving credit mortgage can be ideal. As you progress with your project, you have the flexibility to withdraw funds as required, up to the pre-agreed limit.

Offsetting Mortgage vs Revolving Credit Mortgage

Offset mortgages and revolving credit mortgages can be powerful tools for those who want to leverage their savings to reduce their mortgage balance and save on interest. Like any financial product, it's important to understand how it works and whether it's the right fit for you. Ultimately, the best option for you will depend on your financial situation and goals, so it's important to talk to your trusted Mortgage Adviser to compare different lenders and to find the best deal.