Get a line of credit loan and unlock the equity in your home to finance a renovation or invest in property.
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A line of credit, also called an "LOC" or home equity loan, allows you to borrow money using the equity in your property.
Equity is the value of your home minus any money you owe on it. If your home is worth $500,000 and you owe $200,000 on it, then your equity is $300,000.
A line of credit allows you to access your funds when you need them. This type of loan allows the borrower to choose how often and how much to borrow against the equity in the house. The lender sets the initial limit to the credit line using similar criteria to a regular home loan.
Unlike a regular loan, a line of credit allows the borrower to access the funds as they are needed, and the money doesn't have to be used all at once.
How is interest calculated?
If you have a line of credit for $150,000 but you decide to only use $80,000 for a home renovation then you will only pay interest on the $80,000. If you then decided to use another $50,000 for a holiday, then you would pay interest on the total amount of $130,000, with $20,000 left over.
Some lenders will allow you to capitalise the interest until you either reach the limit of your line of credit loan or you reach a certain percentage of the limit.
Once money has been drawn down from the line of credit loan, it does not have to be repaid right away. Repayments are only required when the loan limit has been reached. If a borrower decides to make repayments, it can be added to the line of credit. For example, if a borrower takes $10,000 from their line of credit and they pay back $100 a month, the repayment can be drawn from the line of credit so that the amount drawn down is now $10,100.
Some lenders charge monthly or annual fees on a line of credit equity loan. The average fee for a line of credit is around $700 a year. This fee can be charged monthly, in six-month increments, or on an annual basis.
Lenders may charge application, discharge or valuation fees too.
Line of credit loans versus personal loans
Line of credit loans typically have much lower interest rates than personal loans. If you're disciplined in paying off your line of credit, you could potentially save thousands of dollars in interest. Let's look at an example.
- Personal loan. If you took out a $10,000 personal loan for 5 years at a typical interest rate of around 14.5%, your monthly repayments would be $235. Over the course of the loan you would pay $4,117 in interest.
- Line of credit. If you borrowed $10,000 against the equity in your home using a line of credit loan, you could find an interest rate of 5% or lower. On a 5% interest rate over 5 years, your monthly repayments would be $188.71 and you would pay $1,322.74 in interest. That's a savings of more than $2,794.
However, this requires the discipline to repay your line of credit loan in a timely manner. If you ended up letting your line of credit loan stay open for 15 years, you would end up paying $4,234.29 in interest, eclipsing the amount you would have paid on a personal loan.
How can I minimise the interest payable?
You can save money on the interest payable over the life of the loan by using your income to offset the loan amount. This can be done by depositing your income into the loan account and then withdrawing money needed to satisfy living expenses from the line of credit as needed. With this method, the interest on the loan is only calculated on the remaining balance of the account, which will lower your interest charges.
A homeowner can use the money in a line of credit equity loan for anything. The funds can be accessed to go on holiday, to renovate or make repairs on the property, to pay bills or to buy a new car. There is no need to submit an application to the lender to notify them what the money will be used for.
Simply withdraw the money from the account.
How to use a line of credit loan to invest
A line of credit loan can represent a good opportunity for investors. For example, if your property is worth $400,000 and you've taken out a mortgage of $250,000, then you have $150,000 worth of equity. This is a substantial amount of money that can be used to fund the purchase of another property if you're looking to diversify your portfolio.
There are many reasons why some would be interested in obtaining a line of credit home loan, however there are advantages and disadvantages that must be considered.
- Accessible. Lines of credit loans are easier to obtain than other types of loans and credit cards.
- Purpose variety. The line of credit loan can be used for a variety of purposes (e.g. home renovations, property purchase, holiday)
- Flexibility. The funds can be withdrawn easily via cheque or ATM card linked to the loan. Some lenders provide borrowers with the ability to withdraw funds through an online banking system or a telephone banking system.
- Additional repayments. Extra repayments on the loan can be made at any time which can help reduce the amount of interest paid over the life of the loan.
- Low-interest rates. One of the most attractive benefits of a line of credit loan is that it often has lower interest rates compared to other products such as personal loans or credit cards.
- Difficult to manage. As it's easy to access the money, and most line of credit loans involve a large amount of money, the borrower needs to be financially disciplined to manage this type of loan.
- Security. If the loan isn't repaid according to the terms of the contract, the lender can take the property as payment.
How can I protect my home?
From a lender's point of view, they have the security of your home in the event that you default on the loan. If your property depreciates in value, you will end up with less equity and could even end up owing more on the loan than your home is actually worth. This is why it can be a good idea not to borrow or use the full amount of equity available. Always leave a buffer.
- Consider minimising the amount of interest payable on your loan by offsetting it with your income.
- Don't withdraw more funds than you need.
- Compare a range of line of credit loans to ensure your getting a competitive deal.
If you're thinking of taking out a line of credit loan, you should consider whether:
- You have the discipline to stick to a budget
- You have not borrowed against equity that has been calculated on an inflated price
- You have the restraint to not use all the funds at once
- You have a cash buffer to protect yourself from rising interest rates
Example: Rod's line of credit
Rod's property is worth $300,000 and he originally borrowed 80% LVR (loan-to-value ratio) with a $240,000 loan. As he repays the loan over time, he can access any existing equity that is available.
This means that when the loan balance is reduced to $180,000, Rod could potentially access $60,000 in equity as this would represent the total amount that he has paid off.
As Rod is a disciplined borrower, he believes that a line of credit loan will enable him to fund his retirement travel plans.
If your applying for a line of credit you may need to satisfy the following criteria or supply the following information:
- Applicants must be at least 18 years old
- Name and address for each borrower
- Purchase date and price of the home
- Employment income
- Income from any other sources
- Outstanding balance on the current mortgage(s)
- The monthly payment on the current mortgage(s)
- Estimated market value of the home
- Requested loan amount
- Photo ID for all borrowers
- Previous address, if at current address for less than two years
- Previous employer, if with current employer less than two years