It’s extremely common for applicants to consider re-drawing against their mortgage to borrow money for their next vehicle purchase. There are seemingly two perceived benefits in arranging finance this way, convenience, and interest rate.
Homeowner applicants may think it’s convenient to re-draw on their mortgage because it’s credit they already have. This may be the case if they have paid sufficiently more than the minimum repayment over the course of their home loan and have a re-draw facility available. Otherwise, they will still have to jump through the traditional hoops associated with re-mortgaging their home. This can be extremely time-consuming and frustrating, resulting in delayed settlement times which can disgruntle vendors. This can mean missing out on the vehicle you want!
Many homeowner applicants are fixated on interest rate. Due to the nature of these assets, home loan rates are typically lower than vehicle rates. Looking at the disparity in these interest rates, many believe re-drawing on your mortgage supersedes standard vehicle finance. This may be true, but only if you’re disciplined enough to contribute the required extra repayment to your mortgage over the set term, typically 5 years. Most borrowers are unaware of what this minimum repayment is and are not disciplined enough to make it month on month. Un-accounted for expenses such as repairs, emergencies, and holidays are very common. It’s typical for applicants to revert to paying their base mortgage repayment when these expenses arise.
Over 5 years, this can result in total interest paid completely blowing out.
Take the following example:
Martha wants to borrow $50,000 for her next vehicle purchase. She has two options –
- Borrow money over 5 years at 5% using a standard car loan
- Borrow money over 30 years at 3% by redrawing against her mortgage
Borrowing $50k over 5 years at 5%, total interest payable will be $6,380 ($25 per week). If Martha decided to pay this loan out early, interest payable will be even less as she will be rebated a portion of the un-paid interest.
Borrowing an extra $50k using her re-draw facility at 3% over 30 years will blow out interest payable to $25,670. Let’s give Martha the benefit of the doubt and assume she pays off the vehicle in 10 years using her re-draw facility. Martha’s total interest payable will be $7,780, still higher than that paid ($6,380) using a standard car loan at 5%. To benefit from re-drawing against her mortgage, she would have to pay off the loan in minimum 9 years. How does she know what this repayment amount will be?
Borrowing money by re-drawing against your mortgage can be unnecessarily complex. Why not keep your finance for each of your assets separate and simple?
Interest rate shouldn’t be the only factor in deciding which type of loan suits your requirements.