Mary Holm: Loaded credit card toll on savings

On the climb up the retirement savings mountain, you're slipping backwards if you have a loaded credit card. Photo / Thinkstock

An unpaid balance is like an account earning negative interest

I took your recommendation and joined KiwiSaver in 2007. In March 2013, when turning 65, I will have approximately $25,000 in the account.

We have a freehold house, and I intend to continue working, where my net income is $1500 a fortnight. I will also receive NZ Super. My husband is retired and receives super. We have $50,000 invested with the ASB.

I have approximately $9000 owing on my Visa (grandchildren and holidays). Smile.

Should I take a lump sum from my KiwiSaver and pay the Visa off, or pay the super fortnightly directly into the Visa until finished?

On the climb up the retirement savings mountain, you're slipping backwards.

While it's fine to smile about spending money on grandchildren and holidays, running up thousands of dollars on Visa is not a good idea.

Let's say the interest rate on your card is 19.95 per cent - the most common rate. Having an unpaid balance is like having a savings account earning interest of minus 19.95 per cent.

You need to get rid of that debt as fast as possible. If you can withdraw $9000 from your ASB investment without much in the way of penalties, you should do that.

If not, use any spare money to pay down the Visa bill and finish it off as soon as you can get your hands on your KiwiSaver money.

KiwiSaver tax credit

I am no mathematician, but in your reply last week - about contributing to KiwiSaver versus making extra mortgage payments - you seemed to ignore the KiwiSaver tax credit, apart from saying it was "great".

Surely the tax credit represents an immediate 50 per cent return on annual investment. Or do you not expect it to continue? After all, it has already been halved in the first five years of KiwiSaver.

The issue is not whether the tax credit will continue. Who knows about that? The point I was trying to make last week is that the tax credit is often overrated.

It does indeed give you an immediate 50 per cent return on a contribution of up to $1043 a year. But think about what happens to your KiwiSaver money in the years after you deposit it.

Let's say that after five years your current balance is $12,000. This year, you contribute a further $1043 and get the 50 per cent boost on that. Meanwhile, though, the $12,000 might earn a return of 4 per cent. That takes the return on the total account - $12,000 plus $1043 - to less than 8 per cent.

Some years down the track, your account balance might be $60,000. Earning 4 per cent on that, plus 50 per cent on the new contribution, will bring the return on the total account to less than 5 per cent.

The more years that pass, the bigger the account balance and the more the current year's contribution will be watered down. The impact of the tax credit on the total account's return will get smaller and smaller.

That's why I said last week that for younger people, KiwiSaver is not quite such a good deal, although it's still worth being in - even before we count the first home help.

I hope that's clearer now.

Revolving mortgage

From the Q and As in last week's column about the ANZ and varying payments on a mortgage, it would seem that an answer to the problem may be a revolving mortgage.

My mortgage was with the National Bank, and I was able to make larger payments when funds became available without a trip to the branch, and I could also view the account online.

I haven't done the arithmetic recently, but when I took out the mortgage 11 years ago, judicious use of the mortgage account, linked credit cards and juggling dates of when the credit card payments were made meant that the effective interest paid compared very well with the best fixed rate available at that time.

Even though the mortgage is now paid off, I have kept the account open.

What I used to pay in "mortgage payments" - although there is no such thing really with a revolving mortgage - I now use to save in term deposits.

If there was an emergency and I needed money quickly - and luckily that's still an "if" - I would be able to draw on the revolving account rather than have the penalties involved in withdrawing money early from the savings. I would then pay off the revolving account when the savings matured. Granted this will incur a small amount of interest but that's acceptable in the short term until the savings become available.

What do you reckon?

I reckon revolving credit mortgages work well for people like you - and perhaps for some people unhappy with the ANZ changes - but not for everyone.

With such a mortgage, you combine your loan with your everyday money in one account. If your mortgage is, say, $200,000, you start with an account balance of minus $200,000. You then arrange for your income from all sources to go into that account and take your spending money out of it.

Because you don't spend all your income on the day you receive it, the unspent portion sits in the account in the meantime, reducing the negative mortgage balance.

Mortgage interest is calculated on the daily balance, so on most days you will pay interest on somewhat less than if you held the mortgage in a separate account.

As you suggest, if you put lots of your spending on a credit card - and pay it in full every month - that increases the time between receiving income and paying expenses. That helps to boost the daily balance in your revolving credit mortgage account, further cutting the cost of the mortgage.

And if you have any "spare" money, it's good to deposit that for as long as possible. The lower you can keep the mortgage balance, the less interest you'll pay.

These mortgages work well for self-disciplined people. As you say, you don't have to make regular mortgage payments, but if you don't make a habit of doing that anyway your mortgage could last a horribly long time.

What's more, as the balance in the account reduces over time, in most cases there's nothing to stop you borrowing the money back again. That might be fine if you use the money in a way that will increase your wealth - for example, to make improvements that will raise the value of your home.

But if you spend the money on clothes or entertainment or travel, you could be stuck with your mortgage until you die.

On the good side, revolving credit mortgages are really flexible, and could well suit the recent correspondents to this column who want to vary the payments on their ANZ mortgages.

Another reader in similar circumstances has written to say, "ANZ offered me a revolving credit mortgage and said they would waive the monthly service fee. But the interest is higher than the floating rate."

However, as you point out, the actual interest paid may in fact be lower, because the mortgage balance on most days will be lower. For those with self-discipline, it's worth looking into.

By the way, your current arrangement, of keeping the revolving credit mortgage there to use if you need short-term money, is a great idea, as long as the fees on the account are reasonable.

Update

On October 9, 2010, this column included a letter from a reader urging everyone to buy silver and gold. He made three predictions as follows, with comments on how they've gone:

• For gold: "I am pretty sure we will see US$1600 an ounce by year's end".

The final 2010 price was US$1422 - well up from about US$1300 when he wrote, but far short of US$1600.

• "The kiwi (NZ dollar) will go to 80 against the greenback (US dollar) and on to par." He didn't give a date, but I suggested a year later in my response, and he didn't come back and object.

A year after, the kiwi was worth US77c, up just 2 cents from when he wrote.

• For silver: "over the coming two years or so I see US$100 an ounce".

At the time, silver was worth US$22. On October 9 this year it was US$34 - about a third of his forecast.

Well at least he got the directions right. All three did rise - and gold and the kiwi dollar are higher still now, despite some rough patches along the way. But I hope he didn't bet on his forecasts.

This is not about proving the reader wrong. I wouldn't have been surprised if at least one out of gold, silver and the dollar had exceeded his forecasts.

They are all volatile - pretty much anything could happen.

It's just that forecasting in financial markets is a mug's game. The experts give it a go, but even they often do badly. I suggest we amateurs stay well away.

Let's close this debate with a couple of longer-term observations:

• From a reader: "If you purchased gold at the start of March 2009 [about the time the NZ dollar was plummeting through 50 US cents, and you could have reasonably thought buying an internationally traded commodity like gold was a safe way to protect your wealth], you would not have made a positive return in NZ dollar terms until the start of August 2011.

"This is despite the fact that the 'international price' of your gold in US dollars would have nearly doubled in that time. Just shows gold can be affected by our macroeconomic situation as much as any investment."

My comment: Indeed. Given we buy in NZ dollars, that's the history we should look at - and it's not as pretty.

• Taking an even longer perspective is economist Gareth Morgan: "During the free-floating gold era (1970 onwards) gold has been about 20 per cent more volatile than equity markets, and far, far more volatile than investments in bonds or cash.

"The long-term performance record of gold should instantly give pause to investors seeking to safeguard their retirement purchasing power. The losses borne by investors who bought at the last gold price peak (and still the true record-high in real terms) are mind-boggling.

"From the peak in 1980 to the low in 2001 (which most would consider as a long-term investment horizon), gold prices fell 87 per cent in real terms. And to be generous, I haven't deducted transaction and storage costs over this period."

* Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and best-selling author on personal finance. Her website is www.maryholm.com. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.