What you need to consider before refinancing to a line of credit loan
A line of credit (LOC) home loan or home equity loan allows borrowers to access funds from the equity in their property. This can be used simultaneously or separately for different purposes. Property investors and business owners generally use LOC loans to use the equity in their property for a deposit to buy another property.
If used responsibly, an LOC loan can save you thousands in interest over the life of your home loan if you deposit your income into the account and only withdraw your minimum requirements.
However, LOC loans can be risky for borrowers who do not have good financial discipline. It can be tempting to extend the loan amount to a point where you can no longer service the repayments and this can lead to mortgage stress.
As a result, LOC loans are not suited for all types of borrowers. If you’re thinking of switching to an LOC loan, you need to consider whether you have the due diligence to manage one correctly.
Should I refinance to an line of credit loan?
Before deciding whether you should switch to a LOC loan, you need to identify why your current mortgage no longer meets your needs and whether an LOC loan will offer the benefits and features that you need to fund your lifestyle. You should speak with a licensed mortgage broker to help you decide whether this move is right for you.
An LOC loan can be helpful if you’ve built up a considerable amount of equity in your home, as you can easily access it to purchase other assets or items (such as a renovation or a car). An advantage of accessing your equity in this way is that you can effectively borrow money for a renovation or a car at home loan interest rates (which are typically much lower than personal loan rates).
This type of finance is suited to borrowers who are highly disciplined in managing their everyday finances and those who are money savvy with a strong credit rating.
Be realistic about whether an LOC loan will suit your borrowing needs and weigh up the pros and cons.
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What to consider when refinancing to an LOC loan
- Review current situation. Before switching to an LOC loan with a new lender, decide if an LOC loan will better match your needs compared to your existing loan. While an LOC loan is highly accessible and offers features such as purpose variety and flexibility, you need to ensure that your current home loan doesn’t already offer these features, otherwise you may be costing yourself time and money in the refinancing process.
- Financial behaviour. If you’re thinking of refinancing to an LOC loan, you should think about your financial health and the type of borrower that you are. Do you have the discipline to stick to a budget? Do you have the restraint to not use all the funds at once? Do you have a cash buffer in place to protect you in the event that you can no longer meet your repayments?
- Product suitability. An LOC facility is ideal for borrowers with a good credit history and strong financial discipline. It’s also suitable for people who have built up a reasonable amount of equity in their property. If you don’t think you fit this criteria, then you should consider alternative options such as scouting for a home loan that offers the ability to make unlimited additional repayments and a redraw facility.
- Identify risks. Identify the risks of switching to an LOC loan before moving forward with your decision. Can you afford to pay a higher interest rate that is often attached to LOC loans compared to traditional home loans? Do you have the due diligence to manage the loan responsibly? Are you comfortable with the asset risk associated with LOC loans if you default on your repayments? Talk to your trusted accountant and mortgage broker to make sure you’re in a position to effectively use an LOC facility.
- Switching cost. It’s critical that you crunch the numbers when it comes to estimating your total refinancing costs as this will determine whether or not it’s worth switching. To exit your current home loan, you’ll need to pay discharge fees that range from $150 to $350 as well as government charges and any other applicable switching fees. With your new LOC loan, you’ll need to pay upfront costs such as application fees or legal fees charged by the new lender. Use our switching cost calculator to get an estimate of your refinancing costs. Remember to consult your accountant or financial planner, who can walk you through these calculations.
Refinancing to an LOC facility can be a good way to access equity and consolidate debts for borrowers who have the restraint and discipline to use it correctly. Before switching to an LOC home loan, make sure you’re comfortable with the risks and costs involved.