Take advantage of the existing equity in your home to finance a renovation or property purchase with a line of credit loan
Whether you need to access your existing equity to finance a renovation, property purchase or even to fund your 'bucket list' retirement plans, a line of credit or equity loan can help you realise your personal and financial goals.
As your property increases in value, the difference between the amount you owe on your mortgage and the amount your property is worth is called equity.
Normally you can access the current equity in your home when you sell the asset because the sale price goes to pay off any outstanding amount you owe on your loan, and anything that's left over represents your profit in equity.
With a line of credit or line of equity loan, you can access that extra value earlier to further secure your financial position.
What is a line of credit home loan?
Also referred to as a "home equity loan", a line of credit loan allows you to borrow money using your existing equity.
Equity is the value of your home minus any money you owe on it. In a sense, equity is the amount of your home that you actually own. To demonstrate, if your home is worth $500,000 and you still have $200,000 owing on it, then you have a total of $300,000 in equity.
A line of credit acts as a flexible transactional mortgage that allows you to access your funds when you need them. You can use the funds for a renovation, to purchase a property or car, or even to cover your 'big' retirement plans.
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A line of credit, also called an 'LOC' or home equity loan, is a revolving line of credit with a variable rate that offers increased flexibility for the borrower. 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. While a line of credit usually carries a shorter term than a mortgage, some are available for up to 30 years.
Unlike a regular loan that provides the borrower with one lump sum payment that must be repaid over a specific timeframe, 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. The repayment amount is dependent upon the amount of money that the borrower withdrew from the available credit balance, and in most cases only the interest needs to be paid back.
How is interest calculated?
A line of credit loan allows you to take out an approved amount of your equity which you can use separately for different purposes or all at once. The way in which you decide to use the funds determines how much interest you pay.
For instance, 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 and the remaining $70,000 remains untouched. If you then decided to use another $50,000 for a holiday, then you would pay interest on a total amount of $130,000 with the outstanding $20,000 to use further down the track.
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.
Should I take out a line of credit?
Most lenders offer a line of credit to people that can demonstrate financial discipline. This can be shown by having good credit history and a stable income. Since the borrower can access the money whenever they want, it is tempting to take it out all at once, which is not the best option. The ideal recipient of a line of credit loan is someone that can resist the temptation to use up the loan money on frivolous things.
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.
When purchasing a home, most people put a down payment on the price and then take out a loan or a mortgage for the remainder of the property value. This means that most people start out with at least a small amount of equity in their home- normally 10-20%. In an ideal situation, the property's value will increase over time, and with regular mortgage payments the equity in the house will increase.
A line of credit loan provides you with a line of credit to access the equity you have in the property. In most situations, the credit limit is set at 80% of the value of the property.
The borrower can access the money at any time, without having to apply for it. The borrower can take out as much or as little money as they choose, as long as the amount doesn't exceed 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.
What are the costs?
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.
While it will differ from lender to lender, some banks will charge other fees such as an application fee, valuation fee and discharge fees.
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.Back to top
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.
A line of credit equity loan includes features which:
Allow you a line of credit up to the value of the equity in your home
Your lender will define the value of the equity in your home, so this may cost you a valuation fee to activate your line of credit home loan. Your credit limit will usually be set at around 80% of the value of your property.
Access to funds at any time without making an application to your lender
A line of credit allows you to access the funds with your linked transaction accounts or using internet banking at any time for any amount you choose.
No regular repayments are required until you reach your limit
Your repayments can be added to your line of credit, so for example if you have drawn down $10,000 and your repayment is $100 a month your repayment can be drawn from your line of credit so the amount drawn down becomes $10,100.
Monthly or annual fees
There can be fees associated with a line of credit home loan which may be charged monthly, six monthly or as an annual fee. On average a fee for a line of credit will be several hundred dollars a year.
You can save on interest using your income to offset the loan amount.
You can have all of your income deposited into your loan account and then draw your living expenses from your line of credit as you require them. The interest on your loan is then only calculated on the remaining balance of your account saving you interest charges.
While there are risks and costs associated with a line of credit loan, there are a range of benefits to being able to draw on the equity in your loan when needed. With a line of credit equity loan you could benefit from:
A home loan is a cheap form of credit because the interest rate is much lower than that on credit cards or personal loans and even on some margin loans.
Avoid fees for additional repayments or redraws
While a standard loan may allow you to deposit more into your loan account and then redraw when you need it, there are often fees associated with additional repayments and redraw facilities however with a line of credit loan you can access your equity amount for a set annual fee.
You can use the money for whatever you choose
This means you can withdraw money from your line of credit equity loan to pay your bills, renovate, go on holiday or buy a new car and you don't need to make an application to the bank to show them what you are using the money for. All you do is withdraw the money.
Increase your net worth by using a line of credit for investments.
If you use the equity in your home to make investments which offer a good return and strong growth rate, you can by increasing your net worth as you use your money wisely to accumulate more appreciating assets.
If you have the financial discipline to manage your spending using a line of credit equity loan, you can leverage the equity you have accumulated in your home to strengthen your financial position and secure your financial future.
How to use a line of credit loan to invest
As investors are often looking for ways to build their wealth, a line of credit loan may 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 features of a line of credit loan that make this type of loan distinct from other loan types.
- Structure. The most obvious feature of a line of credit loan is its structure. This type of loan allows people to use money from a credit limit as needed and it works similar to a credit card. A borrower could be approved for a $100,000 credit limit, but only use $75,000 of it. The repayment amount is based on the $75,000 that was borrowed, which needs to be repaid over the term of the loan. At any time, the borrower can access additional money from the line of credit loan, as long as the total amount withdrawn does not exceed the $100,000 credit limit at any given time.
- Interest is only due on withdrawn amounts. Another unique feature of line of credit loans is that borrowers only have to pay interest on the amount of money that was used, not on the total amount of the available credit. This means that borrowers are not charged interest on unused money. It's a good incentive for people to only use as much money as they need and to avoid withdrawing extra money simply because it's available.
- Credit limit. The credit limit of a line of credit loan is dependent upon the property value. This is different than with other loans, which are usually dependent upon the equity of a house, the borrower's credit history, and their income. The more a person's property is worth, the higher their credit limit will be.
- Flexible use of funds. The final feature of a line of credit loan is that the money can be used for a variety of purposes. The funds can be used for home renovations, the down payment on an investment property, to purchase or refinance a vehicle, to go on holiday, or to pay for a college education.
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.
- Higher interest. The interest rate is usually higher for a line of credit loan compared to a traditional variable rate loan.
- 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. To avoid the lender taking possession of your asset in the event that your unable to meet your repayments, you should ensure that you do not borrow against equity that has been calculated on an inflated price of your home's value.
If your property depreciates in value, you will end up with less equity. When house values drop, the borrower will find out that they now owe more on the loan than what the home is actually worth.
This is why it's a good idea not to borrow or use the full amount of equity that is available. Always leave a buffer.
There is a lot to think about when considering a home loan, no matter what kind of loan you'd like to get and what you intend to use the funds for. Here are some tips to keep in mind:
- Consider minimising the amount of interest payable on your loan by offsetting it with your income.
- A line of credit loan can be a good way to consolidate debts (e.g. personal loans or car loans).
- Don't withdraw more funds than you need.
- Compare a range of line of credit loans to ensure your getting a competitive deal.
Should I take out a loan of credit loan?
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
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