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.
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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.
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