You might feel I’m being a little critical of your efforts

Question

Can you please give me some advice in regards to my mortgage?
 
My partner and I have a home loan of $180, 000; $20, 000 of this is in a direct revolving credit facility on a floating rate of 8.8 %. The greatest part of our loan is fixed at 6.95% until November 2006.  We have managed to fill up our revolving credit facility and are unsure about what to do with it? 

Should we pay $20, 000 off the fixed part of our mortgage and incur a penalty for paying over 5% of the total, pay off only 5% of the total mortgage and build up the direct revolving credit facility again or leave the direct revolving credit facility alone and start up a separate account that earns interest on our excess income?  Your thoughts please.
 
Many thanks,

Deborah

Answer

I assume you mean by ‘filled up’ you refer to the fact that you have repaid the revolving credit $20,000 component of your facility, or it was unused, and in fact have saved a credit balance of $20,000 leaving a fixed debt of $160,000 with $20,000 in hand being in effect $140,000 net owed to the bank.

I’m not sure why you structured the facility in this way but it would appear little thought was given to your servicing capacity when the borrowing was arranged.

If careful thought had been given to cashflow analysis you would have discovered that in fact you did not need the floating portion at the level suggested and could have in fact taken a larger component that could have been repaid without concern for penalties.

You might feel I’m being a little critical of your efforts and I do not mean to convey that message, more, I’m keen for you to understand that fixed terms, floating portions and interest rates are only part of the consideration when properly structuring a debt facility. It is more important than ever when the facility is for your own home and not for investment purposes which do give some tax relief to servicing the interest costs and losses.

The fixed rate component is at an attractive rate given our today’s market rates and it would be unwise to disturb that, beyond the paydown of the allowed 5%. This will leave you with a surplus sum. I suggest you invest that short term through to November 2006, but check with your mortgage provider to see what penalty will apply to a larger paydown sum first.

There is likely little or no advantage to you in this strategy beyond having the funds available when the fixed term rolls off. As you will require a gross rate of return of approximately 9.25% to break even with your 6.95% borrowing rate, penalty aside. This is relatively high, for the 10 months available to you - so be prudent.

As a final comment it would appear you have regular surplus cashflow and most likely growing equity in your property – it would be wise to take some advice on how best that might be employed for your benefit.

Original Article published January 2006