You may be familiar with the terms, but do you understand the difference and do you know what option suits you best?
The whole point of revolving credits and offset loans is to save you interest through ‘offsetting’. We’re actually quite lucky in New Zealand to have these types of products because not all countries do. Both of these types of products save you interest, but they do it in different ways.
Revolving credits:
Having a revolving credit loan is like having a really large overdraft. You have the one account that your income can go into and your bills and loan repayments can be deducted from this same account. You can have a debit card for this account and you can use it like any type of transactional account. The interest you pay is calculated daily based on the balance of your account. So the more money you have in the account the less interest you pay. You can make lump-sum repayments and redraw money up to the loan amount limit.
Advantages:
- Some lenders can reduce your credit limit each month, which can help you pay off your loan within a specific term.
- There are no fixed repayments, which can be good if your income fluctuates.
- Adding any savings into this account (rather than a separate savings account) gives you bigger interest saves and avoids the tax on savings account interest.
- If you are disciplined, you can pay off your mortgage faster
Disadvantages:
- All your funds are mixed in together. If you have funds for different purposes it’s hard to keep track of this as it is just one big account.
- If your revolving credit loan is too big you may not have enough funds to offset with and you’ll therefore pay more interest as revolving credit loans are on the higher floating interest rates
Things to consider:
You need to have self-control and avoid the temptation to spend up to the credit limit – as this will keep you in debt for longer.
Offset loans:
If you choose an offset loan set up, the lender takes into account any savings or funds you may have in other accounts and deducts this from the loan total before calculating your interest. For example, if you have a $500,000 home loan and $25,000 in your savings account you would only pay interest on $475,000. The interest is calculated daily, so the more money you have in your accounts the less interest you pay. Interest is calculated at the floating (or variable) rate.
With offset loans, the money that you are ‘offsetting’ with can sit in multiple bank accounts and are therefore separated.
Advantages:
- Paying less interest means you can pay off your loan faster.
- It is often possible to link many different accounts (partners, parents, etc) to generate more savings on interest.
- You can have your money in different accounts. This makes it easier to track funds that are to be used for different purposes.
Disadvantages:
- If your offset loan is too big, you may not have enough funds to offset with and you’ll therefore pay more interest as offset loans are on the higher floating interest rates
Things to consider:
- Any savings that are offset will no longer earn interest. (However, interest earned on savings is usually much lower than the interest paid on debt, so the offset will likely be worthwhile).
- Offset loans are always on the floating rate
How to choose the right option for you?
Ask yourself these simple questions:
- Do you like to keep your money in different ‘pots’ or accounts?
- Are you sometimes unorganised with your money?
If you answered yes to either of these then I would suggest that you use the offset option. The revolving credit option is for people that are very organised with their finances and don’t mind their funds being all mixed in together.
Get in touch if you’d like to talk about the formula for working out the right size revolving credit or offset loan – because getting this right will save you even more.
