By Mary Holm, independent financial writer. Article reprinted from Holm Truths* with permission from Mary Holm.

Revolving Credit Pros

• Get credit for income & savings
• Can borrow for other things
• Flexible payments

Revolving Credit Cons

• Requires discipline
• Variable rate only
• Monthly bank fee

Traditional Pros

• Less discipline needed
• Loan balance falls over time
• Variable or fixed rate or both

Traditional Cons

• No credit for income & savings
• Relatively inflexible

Revolving credit mortgages work brilliantly for some people, disastrously for others. But first, what are they? The easiest way to explain such mortgages is via an example.

Let’s say you get a $50,000 revolving credit mortgage. You might use $30,000 of it to buy a home – perhaps along with a traditional mortgage. The remaining $20,000 is there for you to borrow if and when you need it. Typically, the loan will be linked to your cheque account. If that account had a balance of $1000 before you got the loan, it will have a balance of minus $29,000 after you’ve withdrawn the $30,000. From then on, you can pay off the loan at any speed you like, or you can take the balance to minus $50,000 whenever you wish, just by writing cheques or making direct debits.

Each month, you pay interest on the average loan balance. And that’s where the fun begins. If you put all your income into the account as soon as possible, and pay all bills as late as possible, you will keep the loan balance down for as long as possible. And every day counts when the bank is calculating your average balance. What it means is that any money you hold, whether for a day or several months, is being credited against your mortgage, lowering your interest bill.

To make the most of it, arrange for income to be direct credited into your account, and bills to be direct debited on the last payment date. Also, put as much as possible on credit cards for the credit-free period. That way, you don’t pay for the items for up to 55 days from purchase date.

Revolving credit works particularly well for people whose income or spending is irregular and lumpy. They’re more likely to have large amounts of cash sitting in the bank for a while. And self-employed people, who might accumulate large sums to pay income tax and GST, can credit that money against their mortgage until tax payment day. (True, they could otherwise earn interest in a savings account. But that interest is lower than the mortgage interest rate, and it is taxable.) Still, anyone who deposits income fast and pays bills slowly can benefit from a revolving credit mortgage.

There’s just one problem, and it’s a big one: Discipline. A revolving credit mortgage is still a home loan, which you should want to pay off over time. It’s best, therefore, to lower your loan balance each year. If you can’t resist the temptation to take a trip or buy a car you don’t need, by adding it to the mortgage, you could end up paying interest forever. A couple of tests: If you always, or almost always, pay your credit card in full within the interest-free period, and you find you can save some of your income, you can probably handle a revolving credit mortgage. If not, such a mortgage might cost you lots more than it saves you.

Revolving credit mortgages have a couple of other drawbacks, too:

• You can’t get a fixed rate mortgage; they are all variable rate loans.
• While the interest rate is usually the same as on traditional variable mortgages, many banks charge a fee on the revolving credit cheque account. Still, in most cases this cost will be offset by the lower interest paid – if you are disciplined!

Many people find a combination of both types of mortgage works well. It limits the temptation to overspend; forces you to reduce your total mortgage balance over time; and gives you the option of a fixed rate on your traditional loan. There are no extra charges if you take out a combination loan when you buy a property. But if you want to switch later, to make part of your mortgage a revolving credit loan, you may have to pay a fee.

*Holm Truths is an independent quarterly newsletter distributed by companies to their employees, superannuation scheme members, clients and the like. Any views or information given in the article are not necessarily the views of AMP.