A line of credit, or revolving credit, is a very useful facility to have as part of your mortgage structure. The way it works is that you are committed to pay back only the interest each month and interest is charged only on the amount borrowed. Repayments of principal can be made at any time without penalty and the more you repay, the less interest you pay.
One key advantage of a line of credit is that if you run short of funds you can spend or withdraw up to the limit that has been set. This means that you can pay all your spare cash into your line of credit to keep the balance and the interest down, knowing you can grab it back at any time. If you have a mortgage, the best return you can get for your emergency savings is to ‘invest’ it in a line of credit. The return you get will be the interest you save on your borrowing.
Some mortgage brokers and lenders advocate using a line of credit as a transaction account for receiving income and paying all your living expenses. In theory, this will ensure your loan balance is kept as low as possible. In practice, this system usually fails because unless you are very disciplined it becomes almost impossible to keep to a budget. It is better to instead make a regular payment each payday into your line of credit to reduce the balance.
Some banks are now offering customers the ability to offset balances in a range of accounts, which is a great way to keep your savings separate from your mortgage. You will only pay or earn interest on the net balance of the range of accounts. The more you save, the more you will crunch your credit!
Liz Koh is a financial adviser. Her disclosure statement can be obtained free of charge by calling 0800 273 847. Author of Your Money Personality; Unlock the Secret to a Rich and Happy Life, Awa Press, March, 2008. For free eBooks, go to www.moneymax.co.nz and www.moneymaxcoach.com
