How your savings account could be keeping you poor
We are all told that saving money is a good thing, to put money away for a rainy day, to have an emergency fund but is this always good advice?
Well in short, it depends.
Let me start this with a caveat, I can’t think of any situations where spending all or more than you earn is a good idea (unless you count buying assets that appreciate in value and or give you an income as spending, I would count this as ‘investing’) and you should always have access to an emergency fund (traditionally 3 months pay) however savings in it’s traditional sense isn’t always the best advice.
You should always apportion part of your income to building wealth. It makes financial sense that for every dollar you earn you want part of that dollar to be going to be accumulating assets that will return you an income above inflation. Savings have traditionally been a way that people have sought to slowly build an asset base. But in times when inflation is running higher than or at pace with the rate you are paid in your savings then what should you do?
Having money put aside for emergencies is Personal Finance 101 however is there a better way of doing that?
In todays inflationary environment where incomes are not rising in line with expenses in most cases putting money in a savings account is often not the best use of your money. A savings account or term deposit that is taxed at your RWT and that provides a net return less than the inflation rate, is essentially losing money as the purchasing power of those funds is going backwards.
So what is a better use of money instead of saving? What about having an emergency fund? Is there a better way to be doing this?
At Home Loan Studio, our mission is to help our clients get ahead financially. One of the key things we address with all our home loan clients is how to use loan structure to reduce interest costs and accelerate mortgage repayments, so if you have an emergency savings fund it may work out better for you to use those funds to reduce the interest you pay on the mortgage while still having the ability to draw on them at any stage should an emergency crop up. Two types of products that can really help with this are revolving credit facilities and offset loans.
Revolving Credit Facilities
Revolving credit facilities operate similarly to an overdraft. They provide a flexible borrowing option where you can draw funds up to an approved limit, repay them at any time, and then draw again as needed. This type of facility is integrated with your everyday transactional account, allowing you to manage your mortgage and daily finances seamlessly.
Key Features:
Flexibility: Borrow and repay funds as needed within the approved limit.
Repayment Options: Make extra repayments without penalty, which is ideal for managing fluctuating incomes.
Access to Funds: Immediate access to additional funds for emergencies or unforeseen expenses.
Availability: Widely offered by major banks with typical limits ranging from $200,000 to $350,000.
Offset Loans
Offset loans are structured to reduce the amount of interest you pay on your mortgage by linking one or more savings accounts to your loan. The balance in these savings accounts offsets the mortgage balance, thereby reducing the interest charged. This allows you to effectively use your savings to lower your mortgage costs without actually using the savings to make direct repayments.
Key Features:
Interest Savings: Reduce interest charged by offsetting the mortgage balance with linked savings accounts.
Flexibility: Link multiple accounts to your mortgage, providing more control over interest charges.
Tax Efficiency: Potential tax benefits for property investors, as the funds offsetting the mortgage are not considered taxable income.
Limited Availability: Offered by select banks such as Westpac, Kiwibank, and BNZ.
So what does this have to do with my savings?
Well if you have money sitting in savings at 5% and usually a close to a third of that is going to tax so lets call it a net return of about 3.5% and then you are paying 7% on your home loan, in most cases it would make more sense to ‘sit’ your money in a revolving credit and repay your lending or use it to offset some of the interest you are being charged.
When deciding between a revolving credit facility and an offset loan, consider your financial goals and management style. Revolving credit facilities offer greater flexibility and are ideal for those with fluctuating incomes or the need for occasional large expenses. Offset loans are beneficial for maximising interest savings without increasing repayments and can provide additional tax benefits for property investors.
There is no blanket rule here and the above is not personalised financial advice it is just an example of what some people are able to do to offset their interest costs and reduce the time it takes to pay off their home loan. There is no one size fits all.
However if you have a decent emergency savings or rainy day fund and you also have a home loan it may be worth considering whether any of the above might apply to your situation; please come and chat with us and we can help talk you through your options and what it would mean for your situation. Whether you choose a revolving credit facility or an offset loan, our goal is to help you make informed decisions that will save you money and accelerate your path to financial success.