The advantages and disadvantages of line of credit home loans

Sometimes large sums of cash are required relatively quickly to deal with unexpected circumstances. 

You may have to deal with emergency medical expenses, emergency home improvements, or you may just feel it is time to want to renovate your home. 

Utilising the equity in your own home as a deposit for an investment property, is also a worthy reason to access extra cash.

If you have a reasonable level of equity in your home, a line of credit home loan can help you do this.

InfoChoice helps you compare over 50 home equity home loans. The lowest interest rate is State Custodians Low Rate LOC <70 IO with a variable rate of 2.83 per cent (comparison rate 2.85 per cent). It features a minimum loan of $100,000 and a maximum loan of $1 million. Another loan to consider is Heritage Bank’s Home Advantage Living Equity $250,000 to $699,999 with a variable rate of 4.35 per cent (comparison rate – per cent).

What is a line of credit home loan?

A line of credit is an agreement between you and your bank that gives you access to a predetermined amount of credit whenever you need it. 

Any money you borrow as part of your line of credit home loan is generally secured against the equity in your home.

For instance, if you borrow $400,000 from the bank and use a $100,000 deposit, you will have $100,000 in equity to draw on. As the value of your home rises, as it inevitably will and despite any downturns in the market, your equity will rise with it.  

If you meet the lending criteria of your bank or financial lending institution, it is possible for you to take out a loan against a proportion of the equity you have.

Essentially, it is like a personal loan or credit card but the money comes out of the equity in your mortgage.

A line of credit, gives you a pre-approved credit limit. You are able to borrow as much of this pre-approved sum as you like to put it towards whatever you need to spend it on. Interest will be paid on the outstanding balance.

Loan differences

As far as how much money you can borrow, a line of credit is similar to the amount you would be able to borrow with an unsecured personal loan.

Traditional personal loans include a fixed term, however a line of credit allows you to access extra money whenever you need it, so you don’t have to apply for another loan each time you need access to money.

With a personal loan, you receive a lump sum. This may suit you if you require a one-off amount of cash.

However, with a line of credit, you can use it as often as you like as long as you remain within your credit limit. So if you have made several repayments you can redraw the money at any point giving you money as you need it.

In this respect it is very similar to having a credit card. 

You have a credit limit that has been pre-approved and you can use as much of this amount as you want. There are monthly payments just like a credit card, where you would want to make sure to pay off the interest and a little of the principal if possible. 

Advantages and disadvantages of a line of credit

The difference between a line of credit and your credit card is your interest rates are a lot lower with a line of credit.

The interest you pay is also only on the amount you have used not the entire credit limit. 

The money is easily accessible. You can transfer using online banking and even withdraw cash from an ATM

Another advantage is that you are a lower risk to the lender as you’re using your property as security. Therefore, you will be offered a lower interest rate than other forms of loans.

However, using your home as equity means that if things go wrong you may struggle to repay the loan. In the worst of cases you may even lose your home.

If you are contemplating a line of credit, you may want to consider the following:

  • Make sure to have a solid exit strategy for its full repayment prior to the end of the loan term
  • Ensure that the credit limit on the account is sufficient to allow for this capitalisation. Interest, fees and charges can be capitalised. 
  • Capitalising interest will mean you will reach your limit a lot quicker than if you make regular payments that are interest only.  
  • As with all loans, there are fees. With a line of credit you will often find there is an establishment fee and a monthly service fee. Make sure to do your research before locking in to anything long term.

Lines of credit are most useful when used for covering short-term, undefined expenses that you’ll be able to repay reasonably quickly. Taking out a line of credit can be a good decision when you are recovering from financial hardship, when you want to start a new business or invest in a new market opportunity that will get your existing business off the ground. On the other hand, if you want to finance a specific purchase, you may want to consider taking a loan instead of a line of credit, as loans will usually have lower rates.

Lines of credit are a very convenient way to cover costs, but make sure that the amount you borrow and other borrowing terms are in line with your capacity to repay the debt. If you’re taking out a business line of credit, make sure to consider all your options and the reasons why you need the funds in the first place. 

This update is not financial advice. This article is general news and information.

Home Loans: The comparison rates are based on a secured loan amount of $150,000 and a term of 25 years.

Personal Loans: The comparison rates in this table are based on a loan of $30,000 and a term of 5 years unless otherwise indicated in the product name with^, in which case, the comparison rate is based on a loan of $10,000 and a term of 3 years. The comparison rates are for unsecured personal loans only for the relevant amounts and terms. The comparison rates for car loans and secured personal loans are for secured loans unless indicated otherwise.

WARNING: This comparison rate applies only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. Comparison rates are not calculated for revolving credit products.

The products compared in this article are chosen from a range of offers available to us and are not representative of all the products available in the market and influenced by a range of factors including interest rates, product costs and commercial and sponsorship arrangements

InfoChoice compares financial products from 145 banks, credit unions and other financial institutions in Australia. InfoChoice does not compare every product in the market. Some institutions may have a commercial partnership with InfoChoice. Rates are provided by partners and taken from financial institutions websites. We believe all information to be accurate on the date published. InfoChoice strives to update and keep information as accurate as possible.

The information contained on this web site is general in nature and does not take into account your personal situation. Do not interpret the listing order as an endorsement or recommendation from us. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. If you or someone you know is in financial stress, contact the National Debt Helpline on 1800 007 007.

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