Alan Hartstein
Georgia Rose
Mary Flory
A line of credit home loan — sometimes simply referred to as a ‘line of credit’ or a ‘home equity line of credit’ — allows you to tap into your property’s equity without refinancing.
But this type of loan isn’t right for everyone. Learn more about the pros and cons before you move forward.
What is a line of credit on a home loan?
A line of credit is a revolving credit facility from which you can withdraw a lump sum or regular amounts over time. In some ways, it works similarly to a credit card. You draw down on your home’s equity when needed, up to the predetermined limit, and repay what you borrow, repeating the process if desired.
Unlike a personal loan, car loan or credit card, a line of credit does not require you to make regular monthly repayments as long as your balance does not exceed your credit limit.
You can use the funds however you want and only pay interest on the amount you use. This flexibility can be critical if you’re strapped for cash and suddenly require money for a specific purpose, such as a medical emergency.
The line of credit must be repaid by the end of the mortgage term, but, in most instances, paying back the debt as soon as possible will reduce your interest.
Interest rates
Interest rates for a line of credit vary among lenders but are almost always higher than typical home loan rates.
For example, as of this writing, the Greater Bank’s base rate for a line of credit is 8.80% p.a. — significantly higher than the 5.95% p.a. comparison rate available on the Bank’s discount variable rate home loan.
How a home equity line of credit works
Eligibility
Most lenders in Australia only offer lines of credit when you have achieved an appropriate level of equity in your home.
However, each lender will have its own terms and conditions outlining the amount you can borrow. For instance, some lenders may require you to have a loan-to-value ratio of 80% or less — meaning the amount you still owe on the property must be less than 80% of the current appraised value.
In general, the lower your loan-to-value ratio, the lower your rate. That’s because the more equity you have in your home, the less of a risk it is to the lender.
Example: If your home is worth $500,000, and you have $300,000 left on your mortgage, your loan-to-value ratio would be 60%. So, if the lender requires a loan-to-value ratio of less than 80%, you’d be eligible to apply.
Credit limits
Some lenders may have minimum and maximum loan amounts, such as $15,000 to $1,000,000, regardless of your specific home’s value. However, outside these limits, lenders generally cap the amount you can borrow at 80% of the equity.
Example: If your property is worth $500,000 and you have $300,000 left on your mortgage, then you have $200,000 in equity. Eighty per cent of $200,000 is $160,000 — so, if the lender has a loan maximum of 80% of your equity, then $160,000 is the maximum amount you can borrow.
Repayments
As long as your balance does not exceed your credit limit, a home equity line of credit does not require you to make regular monthly repayments. However, you still need to repay what you borrow.
There are essentially two options for repaying your line of credit:
- Principal and interest. The benefit of a principal and interest line of credit is that you repay the principal on the loan and don’t fall into the trap of merely paying off the interest.
- Interest-only. An interest-only line of credit often means lower repayments, as you must only pay interest, not the principal. This type of repayment structure may allow you to pay toward the principal at certain times, helping to lower your overall debt.
Pros and cons
A line of credit can be a useful tool when you need to access cash regularly, just as long as you’re aware of the pitfalls. Before making any decisions, speak to your current lender, a financial planner or a mortgage broker.
Pros
- You have access to the money when you need it. A line of credit loan allows you to access your equity as needed. You can use the money for anything you want, from an investment property to a holiday. It can also provide a buffer in emergencies, like unplanned medical expenses.
- Flexible repayment structure. Unlike other types of loans, you don’t have to repay what you borrow in regular instalments. You just need to stay within your limit and pay it back by the end of the term.
- You can choose only to pay interest. You can structure your line of credit so you only have to repay interest on the amount you borrow, freeing up money for other expenses.
Cons
- Availability. Finding a lender offering a line of credit can be a challenge, as many banks have stopped offering this option — or simply make them too difficult for most borrowers to get. Offsets and redraws may be offered as an alternative.
- Reduces the equity in your property. Using a line of credit will undo your hard work in building up equity, and the money borrowed may take years to pay off.
- Higher interest rates. A line of credit has associated fees, plus lenders typically charge higher interest rates than you may currently pay on your mortgage. However, the interest rate will still likely be less than it would be for a credit card.
- Requires discipline. Having a line of credit requires a disciplined approach. If you fail to repay what you borrow, and the interest accumulates, the debt can grow unmanageable. If it surpasses the total value of the property, you could end up owing money even if you sold the house.
Frequently asked questions about line of credit home loans
You’re typically required to pay a one-off establishment fee when taking out a home loan line of credit. Monthly service fees, government fees and settlement fees may also apply, as well as any interest on borrowed funds. Interest rates for home loan lines of credit vary among lenders but are typically lower than that of credit cards and higher than other types of home loans.
Both types of loans use the equity built up in your home differently:
- A line of credit home loan is a revolving credit facility that lets you tap into your home’s equity when and if you need extra cash.
- A home equity loan works more like a typical loan: you borrow a set amount against the equity in your home. Then, you repay that one-off lump sum through regular instalments over the loan term, paying interest on the entire amount borrowed regardless of when or if you use it.
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