What is a line of credit?
A line of credit is a home loan facility that lets you access the equity you have built up in your property, which will give you the flexibility to tap into those funds at your discretion. You may have certain times where you require a large sum of money, either for a medical emergency, investing in another property or wanting to do a home renovation. A line of credit will allow you to draw the money up to a pre-approved limit easily and without the need to apply for more money each time.
How does it work?
A line of credit is like a credit card, you are approved for a limit of funds based on how much you want to borrow against the value of your property. For example, your home is valued at $500,000 and you want to borrow 80% of the value, you would have a line of credit limit of $400,000, available to use as and when you need.
What are the benefits of a line of credit?
The primary advantage of a line of credit is the ability to access borrowed money easily, without the need to apply for more finance.
Another benefit is you can treat your account like a transaction account. You can reduce interest costs by having your pay deposited into the account. Interest is calculated on the daily balance so by holding your pay in the account it reduces the balance and interest you pay.
The minimum monthly repayments on a line of credit can also be lower. Most lenders require interest only repayments, meaning during periods of tight cash flow you can minimise how much you pay on the loan. Remember as well, if your pay is going into the account, weekly, fortnightly or monthly this may be enough to pay the minimum monthly repayment.
Finally, you only pay interest on what you draw down. Whilst you may have a limit of $400,000, if you only draw down $50,000, you only pay interest on the $50,000.
What are the disadvantages of a line of credit?
Given the additional flexibility of a line of credit product, most Banks charge a higher interest rate and additional fees for use of the product.
A major point to consider with a line of credit is how disciplined are you. If you are only paying the minimum monthly repayment you are effectively only paying the interest each month, so you are not paying your loan off. If you are depositing your pay into the account but end up spending more than goes in you are growing your debt, not paying it off.
When would you consider using a line of credit?
You would consider setting up a line of credit when you anticipate that significant expenses (e.g., home renovations, purchasing a car) are going to arise, or you are looking at purchasing an investment property or other investment tools. They can also be useful to consolidate debt (you are better off paying 5% on your home loan than 21% on a credit card), remembering discipline is key.