Line of Credit or Equity Line
A Line of Credit, also known as an Equity Line, can be described as being given a cheque book – with payments due only on the credit you’ve actually used. Basically, it’s an approved amount of borrowings that can be used either all at once, or as needed.
Being approved for a Line of Credit facility is the perfect way of accessing the equity in your home, and the money can be used for things like investments, home renovations, and/or other personal purchases. The main difference between a Loan and a Line of Credit is that with the Line of Credit you’re not required to pay interest on the unused credit.
Being offered a Line of Credit from a lender can be very enticing, because it offers immediate access to money back to the original limit of the loan; and you control the money! When used wisely, a Line of Credit can be a lifesaver. It might offer you immediate relief from an emergency or access to funds for investment purposes. However, it can also cause devastating heartache for people who have low, or even average, financial management skills.
An example: Let’s say you’ve been approved for a $200,000 Line of Credit. You might choose to invest $60,000 in the share market, or even use the total $200,000 all at once. If you chose the former, interest would only be payable on the $60,000, because the remaining $140,000 would remain untouched. Then, let’s say you decided to use a further $70,000 for house renovations; now you’ll be paying interest calculated on $130,000 ($60,000 for shares and $70,000 for investing in your home), thus leaving a remainder of $70,000 to use at a later date.
What is a Line of Credit?
Let’s first discuss what a ‘Line of Credit ‘actually is. A Line of Credit, or LOC, offers people access to the equity in their property, as they require it. It’s generally a single loan facility with the limit of the loan staying in place for the entire term of the loan. The interest rate applicable is usually slightly higher than the standard variable rate – possibly 0.15% higher. You might like to think of it as an overdraft against your home, at home loan rates.
Who Uses a Line of Credit?
- Business owners often use an LOC instead of a business overdraft to purchase equipment at lower interest rates than business loans, or to assist with cash flow;
- Property investors might favour an LOC to either finance a property purchase or to pay for home renovations using their existing properties’ equity, without having to go through the application process for a new loan.
- Home occupiers can use an LOC as a means of reducing the interest payable on a loan. Homeowners can have their salary deposited into their LOC account, with everyday purchases being made on the loan – similar to a savings account. In this situation the average balance of the loan is lower, thus saving interest.
- Another way that people might choose to use an LOC is to deposit their entire salary into the LOC and use a credit card for daily living. The idea is that, at month end, the credit card is paid off.
Unfortunately, we find that, under this structure, 95% of people spend more money than they earn
So this structure does not work for them. Yes, it may look workable on a whiteboard, but we do know that most people don’t really know how much they’re spending (as happens with credit cards), so this system is certainly not recommended for anyone who is not financially diligent.
Today, we see many lenders still offering a Line of Credit as a loan option. Ideally, this LOC will provide access to cash that can be used for property renovations to increase a property’s value, or for a deposit on an investment property. The worst-case scenario is people can simply use this money for a well-earned holiday, or just use for everyday expenses, and at the end-of-the-day they’re still left with the same loan balance for 30 years.
So you can see that there are situations where a Line of Credit can be an ideal solution, but, as with all mortgage products we know the key to determining whether a Line of Credit is the right solution for you will be to speak to an expert finance adviser.
Know that we are here to help you, so please speak us if you have any questions at all regarding a Line of Credit facility.