A line of credit loan is a particular type of loan where you can access a specified credit limit using your home equity. In other words, you can use your existing home loan as your cheque account, which you can draw down and repay the amount you have spent.
Suppose you require some financial assistance to implement home renovations, invest in shares, buy a new car, pay for your kids' education bills or even a holiday. In that case, a line of credit loan may be a suitable option to access money.
This article will get you up to speed on key aspects you need to know about the line of credit loans and help you decide if it matches your circumstances.
How Does a Line of Credit Home Loan Work?
Line of credit home loans are a lot like credit cards. Once approved for a line of credit loan, you’ll be able to withdraw and access credit funds from your home loan depending on the equity you have built up in your current home.
Notably, your property value is based on its current value, not the value you bought. So, if there's been an increase in your property since you purchased it, you'll benefit from more equity.
You can withdraw in the form of a lump sum, or smaller amounts over time, up to your total credit limit. Your lender has the security of your home if you default on the loan.
Repayments for Line of Credit Loans
You'll only have to pay interest on what you’ve utilised of your available line of credit facility. So, for example, if you have a $150,000 line of credit and draw down $40,000, you will be charged interest only on the borrowed sum ($40,000). This interest amount is typically added to your home loan each month.
Unlike credit cards or personal loans, with many line of credit home loans, there's no need for making monthly repayments. In addition, you often only need to make repayments once you reach your agreed limit.
You can make interest-only repayments or allow the interest to be capitalised, i.e. added to your home loan amount, up to your approved limit. Capitalising interest will make you reach your approved credit limit faster than interest-only repayments.
Most of the line of credit home loans are interest-only in the initial few years. This means you pay the interest charges and the borrowed sum later.
You’ll have to pay off your line of credit loan before the end of your loan term. Further, with your approved line of credit loan, you’re usually free to make extra repayments to suit your financial situation.
Nonetheless, instead of waiting till the end, making repayments regularly before the end of your home loan term helps reduce the cost of overall interest.
Depending on your lender, you could set up a line of credit with your salary paid directly into your home loan. This could be used for directly paying bills, withdrawing money and making credit card repayments from the loan itself.
Our online mortgage calculator with extra repayments can help you determine how much time and interest can be saved when you make extra home loan repayments.
How Much Equity Can You Borrow?
The equity in your home is calculated by subtracting the current home loan balance amount from the property value.
Most lenders permit borrowing up to 80% of the value of your property. Some may offer you a bigger credit limit, but that is not very common.
For example, your property value is $650,000, and your existing home loan is $350,000.
Assuming that your lender offers 80% loan to value ration (LVR), the amount of equity you can access is 80% of your property value, which is $520,0000 minus the loan amount of $350,000.
The difference, $170,000, is the amount you can easily access through your line of credit.
Home Equity Loan vs Line of Credit
With a home equity loan, you can borrow money against the equity in your existing home to accomplish another objective. It is generally paid out to the borrower in one round sum. It is generally paid out to the borrower in one round sum.
In contrast, a line of credit home loan is more like a credit card. You can borrow up to an approved limit as and when you need it. Where you make regular repayments on your line of credit loan, you can borrow again, depending on your needs.
What to Consider When Taking a Line of Credit Home Loan?
A line of credit home loan is an excellent option for those who need to borrow money for various purposes and don't want to take out multiple loans.
However, this type of loan might not be suitable for everyone. It would be best if you considered the pros and cons, carefully considering your circumstances and financial goals, before making a decision.
Benefits of a Line of Credit Home Loan
- Easy Access to Funds: You can withdraw funds up to the approved credit limit without going through lengthy approval processes. This is specifically helpful in times of emergencies. Further, most line of credit features include chequebooks and/or ATMs linked to the loan. Some lenders also offer phone and internet banking to access the funds easily.
- Pay Your Loan Faster: Generally, with a Line Of Credit, you don't need a bank account. All your income and expenses can be managed through your mortgage. In addition, having your salary deposited into your loan helps clear off the loan faster.
- Financial Discipline: Since limits for line of credit loans are quite large, they enable you to make more significant purchases or expenditures like home renovations while ensuring you are within your borrowing limit.
- Low-Interest Rate: One of the primary advantages of a line of credit loan is the interest rates are generally lower compared to other credit products such as a personal loan. They usually are just marginally higher than home loans.
- Suitable for Debt Consolidation: A line of credit is a suitable way to consolidate your debts by moving your other debts, for example, personal or car loans, into your home loan. This will help you save on interest in your monthly repayments.
- Flexible Repayments: You can make as many repayments on your loan at any time. This will help you reduce the amount of interest to be paid overall. Also, with most line of credit loans, you can make monthly payments. Alternatively, you could choose not to make the repayment if you stay below the limit. Furthermore, after you repay the borrowed amount, you'll be again able to access the full line of credit amount.
Cons of Line of Credit Home Loan
- Security: Since the lender has the security of your home, if you default on the loan, your current lender has the right to take your property. Moreover, when you withdraw funds, you lose the equity you have built in your house.
- Stringent Checks: Banks or specialist lenders implement more stringent requirements for line of credit approval than regular home loans.
- Requires Strict Discipline: When you withdraw money from your line of credit, your home loan amount increases. Further, since most line of credit loans involve significantly large sums, you must exercise fiscal discipline and budgeting skills to ensure you do not misuse the facilities. This may not be easy for people who cannot control expenses.
- Higher Repayments: While a line of credit offers flexible repayments, it could be costly if you take longer to repay the borrowed amount. For example, if you make interest-only repayments or apply interest capitalisation, you'll have to pay more interest in the long term.
When is a Line of Credit Home Loan Suitable?
Taking a line of credit home loan may help in the following scenarios:
Once your equity in your property grows, you can refinance to a line of credit loan with your current lender or switch to a new lender. As a line of credit is a revolving loan facility, you can access it as a lump sum or bit by bit for various purposes. For example, line of credit refinancing is suitable for home renovation, paying for your child's education or even a vacation.
For example, Chris's house is worth $750,000, but he has a home loan of $400,000. This means he has an equity of $350,000. He seeks a line of credit refinancing to access usable home equity towards renovation. He gets a line of credit for $200,000.
Chris draws down $100,000 for renovation purposes, and he has to pay interest on that amount only. If he needs to use an additional $20,000 for the renovations, he will have to pay interest on $120,000 only, not $200,000, which is his approved limit.
Line of credit home loans are flexible options for investors. For example, if your existing home is worth $650,000 and your loan balance is $250,000, you have a substantial $400,000 worth of equity.
You can use this money towards an investment property or grow your wealth by investing in other assets like shares without increasing repayment costs. This is because your monthly payments would only be needed to ensure that the balance does not surpass your credit limit.
Self Employed Borrowers
A line of credit home loan is ideal for self-employed people and business owners with fluctuating incomes who can make additional payments and/or can pay higher interest than a standard variable rate home loan.
It also comes in handy for those who have seasonal cashflows and may need extra funds sometimes.
Final Considerations with a Line of Credit Home Loan
There are a few points to consider before taking out a line of credit home loan.
- Suitability: You need sufficient home equity to qualify for a line of credit loan. In most cases, you'll need at least 20% equity. Your lenders will also want to know your reason for taking out a line of credit loan before approving your application. For example, purchasing an investment property may appeal more than using it to buy a new car.
- Interest Rate: You should know that a higher interest rate generally applies to a line of credit as compared to a P&I loan. Moreover, plenty of financial discipline is needed to repay the entire loan.
- Additionally, depending on lending criteria, some lenders can reduce or cancel your credit limit at any time. This implies that you'll need to have a plan if you're required to pay off the amount at short notice.
- Repayment: Your lender will seek information on how you’ll pay off the line of credit. Depending on your financial circumstances, you could repay the loan before the term, sell off assets, and/or use your savings or income from other sources. Usually, the term for a line of credit is 30 years. Nonetheless, some lenders offer an evergreen line of credit that lasts forever.
- Associated Fees and Costs: Other fees and charges apply along with the interests. While some lenders charge application, valuation, and other such fees, you may also have to pay ongoing monthly administration fees. It is advisable to compare the different rates and potential costs before applying for a line of credit loan.
Alternative Home Loan Products
If you feel that the line of credit home loan is not for you, you could consider other loan options. Some of the other common options include:
- Redraw: You can make extra repayments on your home loan and draw down the equity you’ve built up at a later date. Redraw helps reduce the interest you have to pay without losing access to your money.
- Offset Account: If you require a bigger loan, you could take out a traditional home loan with a 100% offset account. They have lower rates, and you may qualify more easily.
- Reverse Mortgage: An equity-release product that enables you to borrow money while leveraging your equity in your existing home as security.
- Cash-Out Refinance: You can refinance your existing mortgage for a larger home loan and encash the difference with cash-out refinance. However, to access this refinance option, you should have a sizeable amount of equity in your current home.
- The critical difference between a line of credit and cash-out refinance is that when you opt for the latter, your current home loan gets replaced with a new loan.
- Cross Collateralisation: This option allows you to use the equity you’ve built in one property to buy another. It can be risky because if you default on your mortgage repayments, you could lose both properties. Moreover, you can cross-collateralise with one lender only.
If you want to explore more options, Joust offers comprehensive insights on refinance, which can help you save on repayments.
How Joust Can Meet Your Home Loan Needs
A line of credit loan is one of the ways you can structure your home loan. At Joust, we understand that every borrower is different.
That's why our Instant Match tool helps you access a range of flexible home loan options to find the one tailored to your needs. . So whether you're looking for a line of credit loan or another type of home loan, a variable or fixed rate home loan, Joust can help you avail a suitable option at comparatively lower interest rates.
Just answer some basic questions and get ready to compare the three lowest-rate home loans matching your requirements.
Note: The information in this article is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.