The Ultimate Low Rate Credit Card – How To Maintain Liquidity In Your Property
I will get to the ultimate low rate credit card in a second, but if you are like me, then once you have saved up a 20%+ deposit, found the right home, completed any inspections, and finally moved in, you want to start paying it off. In todays low interest environment, with home loans (in 2016) dipping below 4% in Australia and lower elsewhere, it is a perfect time to make some good in-roads into your mortgage. Nothing feels better than taking a chunk out of your debt – or at least not that I plan to talk about here.
Of course you should pay off any higher interest debt first, but once that is done extra repayments on your mortgage will have a drastic impact to your future finances. So rewind a few years and this was the exact situation I found myself in. Interest rates had just dropped down and we were faced with some options:
- Reduce our repayments and live the good life
- Keep our repayments as they were and pay off the house faster
- Dump everything we had into the home loan and try and beat one of our friends in the race to mortgage freedom.
You may have guessed we chose option three. This resulted in what I thought were some very impressive balance reductions. We watched as 10k amounts rolled off the loan. We would celebrate each time we managed to knock off a leading 100k digit.
The Balancing Act
For two people who had been saving like mad before buying a house, being in debt was a strange feeling. With all this paying off, we had to work out how to balance living and repayments. So we structured our finances into four buckets:
Bucket 1: Home Loan
We put everything we earned directly into here. This meant that every dollar we earned was reducing interest as soon as we received it.
Bucket 2: Credit Card
Our home loan came with a credit card by default. I was not sure why as I had never had a credit card before, and disliked the general idea of credit cards. When we asked why, we were given an interesting story about paying for everything on credit, and then paying off the credit card each month from a home loan redraw. The spin was that this would allow us to use the interest free period. As it turned out this was not as beneficial as it may seem. The two graphs below show this. The first graph shows the average credit card costs we had each month, and the home loan redraws we made each month. The second graph shows the net position we found ourselves in each month. As you can see from the net graph, we basically had one month of living expenses interest free for the life of our loan. Not bad, but not sure it was worth it given you had to manually redraw from the load each month to pay it off. Ah well, live and learn. (The graphs show the start and end of our home loan if you are wondering how it was paid off in under 3 years.)
Credit Card vs Redraw
Credit Card vs Redraw Net Position
Bucket 3: Cash
Not everything can be paid for with credit. Some bills require BPay, sometimes you need to use an ATM and pay with real cold hard cash. Thankfully these situations were not too common, and were almost always under $200. So to service this bucket we kept $500 in an account linked to our debit card.
Bucket 4: Existing Assets
Throughout the whole process of saving, we had some of our money sitting in a few managed funds. We talked many times about whether we should sell and move this over to our home loan. Ultimately every discussion ended by leaving it alone. The plan was always to start growing this bucket after we had paid off our home loan. Unfortunately a change made by the company we used to purchase the managed funds (which was its own mistake) resulted in us deciding to cut and run. So we sold them just after we paid off our house.
The Ultimate Low Rate Credit Card
So where does this leave us? After we reached a point where we could have paid off our house we stopped. I knew our car was getting towards its last legs, and didn’t want to find myself in the situation where I had to get a personal/car loan simply because I was no longer able to redraw from my home loan. So I kept the loan active with a $1 outstanding balance (which is still where it sits today).
I am not sure what sort of problems this could cause with my credit, but can’t see how it could hurt it. A home loan is almost always a much better interest rate than you could ever get for a personal loan, car loan, or even if we wanted to get into that margin lending mumbo jumbo. We could even use it for an investment property if needed, although I would have to check the tax implications don’t make that unattractive.
This situation seems to be ideal at the moment. At the drop of a hat I can withdraw $1 to $350,000 with no fees and as of 2016 a low interest rate of just over 4% (how is that for a low rate credit card). Not only does this help with liquidity, but it can also help with diversification and asset allocation – especially if this were an investment property. I don’t plan to keep it like this forever, just until I can grow a large enough safety net to know that I would not need to take out a loan if anything unexpected came along.
One final thought – while I say that it is the ultimate low rate credit card, it is in jest. I have never had to pay interest on a credit card, and never intend to. If you are not in a position to pay off a credit card in full each month then I would recommend getting rid of it as soon as you can and creating your own safety net.
Have just found your blog and really enjoying it so far. We are doing a similar thing with our home loan, basically filling the offset to match the loan amount. No interest but we will still have access to the funds if we need them. Win win!
Glad you enjoyed it 🙂 The ability to pay off a loan and then redraw the money (one way or another) is a fantastic way to minimise loan interest while not having to maintain a seperate “emergency fund”. I think knowing I could pull the excess out again motivated me to see how much I could put in there – nothing like a challenge to motivate me!
Hi Tom,
First I’d like to congratulate you for breaking the 1M mark that’s a huge milestone for most. Second I’d like to ask what made you decide to pay your house off first rather than investing in stocks? with record low mortgage rates of 4% and stock markets averaging 7% seems like a no brainer to go with stocks no?? I’m looking forward to hearing your opinion on this topic!
Hi Brad, and thanks – it was a nice surprise when I realised we had broken the $1m. Your question is a good one. There are a couple of different bits that played into it.
Firstly, interest rates were not at 4% when we got the loan. I think they were high 7’s and we did “what if” planning for 10% (with some scenarios breaking us at 13%). It wasn’t until just before 2014 that they hit these very low levels. So for the majority of the mortgage we were paying (give or take) 6-7%, with average returns around 7+% on the stock market. With the market rise in 2012 we should have dumped everything in there, but again we didn’t know that at the time. The share market is also much more volatile, so even with a larger return, when you factor in tax on profits it didn’t seem worth it. (As a side note a couple of my friends who have not paid off their mortgage have done exactly that, pulled a bunch of money out of their loan to invest in the market).
A second reason is that both my partner and I were badly bitten by the GFC by the sharemarket. This left a bad taste in my mouth and we have been more hesitant in how much of our money is in the market. Thankfully we did put a chunk of money into the market just in time for the 2012 rise (and that felt good).
A third reason is that we don’t live our lives in Excel. So while it may have made sense (and looking back it did) to move the money into the market, we decided that we wanted to pay off the house. I am happy to have debt against income producing assets (margin loans, investment properties etc), but don’t like the idea of loans against non-income producing assets as much, and our house doesn’t produce an income. I know #3 is not logical, but with the house paid off I don’t have to worry about “what if” events. If the interest rate went up to 17% and the sharemarket way down, and we both lost our jobs, we could easily survive for many months if not years. So in some ways I think it was a case of “lock it in Eddy”. We now have a house that can’t be taken away from us, and are more free to invest our money (sometimes with much more risk).
I hope that answers the question. In hindsight, stocks would have been better. In the current climate I think stocks probably are better. However by the time we thought the switch from loan to market was calling, we were at a position where we had the goal in sight and wanted to finish more than anything.