ANALYSIS: For many years, the strategy of putting your regular (weekly, fortnightly or monthly) salary directly into a revolving credit mortgage account has been common practice. When your employer deposits the income, your mortgage is effectively reduced by that much, thereby saving you money on interest.
With interest rates at all-time lows for the past few years, some mortgage holders have drifted away from this strategy; the savings simply didn't make it worthwhile. With interest rates back up in the 5% range, it may be time to look at it again.
Let's use an example where two people in the same household earn $70,000 each per annum. Assuming no other deductions (such as Student Loans), this couple has approximately $4,225 per fortnight arriving (net of tax) in their bank account.
Let's assume their mortgage payment goes out every four weeks, the day before their salary is deposited in their account, meaning they get the full interest-reducing benefit of that money for (practically) the entire month. They also use credit cards with a standard 55-day interest-free arrangement for their expenses. This means that as long as they pay their credit card off regularly, they won't pay any interest on their card.
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If they pay off their credit card monthly, using the revolving credit account method, the couple uses their income to reduce the mortgage by between $4,225 and $8,450 throughout the year. For two weeks, they will have $4,225 in their account, and for the second two weeks (the second pay cycle), they will have $8,450. Just before the couple are paid again, the mortgage goes out, and they pay off their credit card.
With the fixed mortgage rates at roughly 5.5%, they are saving themselves around $348 over the year. Not an amount to be sneezed at but also worth considering whether all the extra arrangements are worth the hassle of what amounts to around $14 per fortnight.
Mortgage Lab founder Rupert Gough: “Some personality types will like the revolving credit strategy, especially those who want to sort their spending into categories. “ Photo / Fiona Goodall
Here are the risks with the revolving credit strategy:
1: If you don't pay your credit card monthly, you will pay around 20% per annum on the debt - roughly four times the mortgage rates. So if you forget to pay the credit card once every four months, you've zeroed out the benefits.
2: Check that your credit cards don't have any annual fees. Some credit cards have fees of a couple of hundred dollars per year, which would almost zero out the benefits of this strategy.
3: Check that your revolving credit account doesn't have a fee. Some banks, by default, don't have any fees, and some remove them for the first couple of years of your mortgage. Any fee on your revolving credit will significantly reduce the benefit of this strategy. Ensure you check the bank doesn't suddenly start charging you a monthly fee.
4: Set the credit card limit to, as a maximum, the amount of your salary minus your mortgage payments over the month. This way, you won't spend more than you are making, meaning you can always pay off your monthly credit card bill.
You can see that most of the risks around the revolving credit strategy involve using a credit card. You could simply attach an EFTPOS card to your revolving credit account, but this, assuming you were spending reasonably evenly across the pay cycle, would half the interest savings, taking the overall benefit for a couple earning a combined income of $140,000 per annum down to $174 per annum or $6.60 per fortnight.
Some personality types will like the revolving credit strategy, especially those who want to sort their spending into categories or "buckets". It does, after all, save some money.
But it has the risk of bringing on what I like to call "The Tesla Effect". That is, you buy an electric car and claim to be doing all you can to help climate change. In this instance, you have your salary deposited into your revolving credit account and claim to be "on top of your finances". If the most significant leak in your budget is a $14 per fortnight additional interest cost, you are most certainly on top of your finances. But I suspect, for most homeowners faced with rising interest rate costs, you could look at your overall budget and find much bigger expenses that could be reduced. In other words, use the revolving credit strategy but don't rely on it as a life-changer even at these higher interest rates.
- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.
