The Good Bad And Ugly About Revolving Credit Loans
There are a number of reasons that people like to have revolving credit loans, but also some very good reasons that people do not like these types of loan facilities.
In this article we look at revolving credit loans, explain how they work, the pro’s and con’s of revolving credit facilities and most importantly where you can get advice on all home loan options.
What Is A Revolving Credit Loan?
A revolving credit loan is a flexible loan or overdraft secured over your property with a mortgage.
The borrowers have a lot more flexibility than with a standard home loan. Like an overdraft these are transactional accounts with a loan limit which means you can borrow up to this limit when required, but you are only charged interest on the amount that you borrow on any particular day.
Traditionally a revolving credit loan has been an interest only loan leaving you to manage the principal repayments on your own. In more recent times some banks have the option of a reducing limit on the revolving credit loan which makes it a principal and interest loan.
When you have low equity in your property (a low deposit) then some banks will insist that all loans are principal and interest – some may even not allow revolving credit loans if there is under 20% deposit or equity.
The Same Loans Facility Known By Another Name
A revolving credit loan is a type of home loan.
To hide the ‘negative nature’ that some people consider of a revolving credit loan some banks have adopted specific names for their own revolving credit facilities.
Here is a list of the main New Zealand banks and what they call their revolving credit loan facilities;
|ANZ||Flexible Home Loan|
|Co-Operative Bank||Revolving Credit Facility|
|HSBC||Premier Home Equity Home Loan|
|Kiwibank||Revolving Credit Home Loan|
|SBS Bank||Flexi Loan|
These are the main New Zealand banks and their revolving credit facilities and by clicking the links you can review then further on the individual banks websites or you can CLICK HERE to check the current advertised home loan interest rates and then you can use our mortgage calculator to work out what your repayments will be.
How A Revolving Credit Facility Works
Very simply with a revolving credit facility (transactional mortgage) your interest is calculated daily on the outstanding balance. To make the most of your revolving credit facility you need to have any surplus or unspent money deposited into this account so that you are paying less interest.
Paying less interest means if you keep the same mortgage repayments then more of your money is applied to the principal repayment. Even little amounts can make a huge difference – initially the savings may seem very small; however with the cumulative effect over time the savings become quite significant.
The following is a list of characteristics common to most revolving credit facilities;
- Revolving credit loans are transactional accounts with an overdraft limit.
- The borrower may use or withdraw funds up to a pre-approved credit limit. The credit may be used repeatedly (like a bank overdraft) without the requirement for any specific bank approval.
- The borrower makes payments based only their loan limit and in most cases only needs to pay the interest only on the amount they’ve actually used or withdrawn. Some revolving credit facilities have limits that reduce just like a standard home loan.
- The borrower may increase their repayments, deposit their wages and salaries directly or make lump-sum deposits to reduce the loan balance and more importantly the interest charged on the outstanding balance of the loan.
- Some banks charge fees (account fees or higher interest rates) for having a revolving credit facility.
The borrower is responsible to manage the account.
Sometimes referred to as “revolting credit”…
Revolving credit loans got a bad reputation in the 1990’s when some mortgage brokers decided to “sell” debt reduction systems. They typically charged a large fee of about $3,000 for this “magical” system that they demonstrated would pay your mortgage off faster without any additional money being required by you – the borrower.
Many people have experienced these types of home loans in the past and do not like them, or at least do not until they are explained and set up properly.
The over-riding principle is that you must earn, or be likely to receive, more than you spend, leaving you a monthly surplus. Assuming this is the case, then your monthly surplus becomes a repayment of loan principal, and this reduces the principal owing on your loan and the interest you are charged each month.
This also assumes that you do not see the available credit and decide to spend that money on things that you really don’t need!
Understanding Why Revolving Credit Facilities Don’t Work
As mortgage brokers we often hear that revolving credit loans just does not work.
In most cases when we hear this it is because those people have previously had a revolving credit facility and it hasn’t worked for them. This does not mean there is anything wrong with the type of home loan facility, it really just means that it has not been operated properly.
It is important that you are getting the best from your home loan and this means understanding what the various loans can do.
The reality is lots of people do not have the discipline to manage a large revolving credit facility or overdraft – they tend to spend what money is available, not have any surplus income and/or decide to blame the revolving credit facility rather than look at how they manage money. This is a fact of life and not really a criticism of people – just a reality.
The problem is many of these facilities get set up as interest only and many borrowers who do not understand how these loans worked are not disciplined and therefore they often can spend years paying their home loans and never reduced the loan at all.
Furthermore many people have been told to put all of their everyday spending on credit cards to get the period of “free credit” which most people find makes it hard to manage any budget.
What You Should Know About Revolving Credit Loans
Many mortgage brokers and bank staff do not explain very well how revolving credit loans work, or more importantly why they often do not work.
If you take the human nature (the people) out of the equation then technically a revolving credit loan does work and work quite well: however there is always a human element that cannot be removed.
People need to understand this and decide for themselves if they are disciplined enough to use this type of loan.
For this reason many people should only have a small portion of their overall home loan structured as a revolving credit facility.
Revolving credit facilities can and do work.
Many bank staff have learned the concept from a text book and know that it works; however they fail to factor in that in life people have challenges, wants and needs and therefore there is a ‘human nature’ that can upset what seems logical to some.
Take the time to understand the concept and find a mortgage broker that you feel comfortable with and they will explain the concept and discuss the pro’s and con’s with you. Of course we would prefer that you use one of our mortgage mechanics (mortgage adviser) to tune up your home loans.
We hope that this has helped you to understand how a revolving credit loans works and for more information you can contact one of our professional mortgage advisers.