What Is A Line Of Credit Home Loan?

What a line of credit home loan is and how they work.

There may be at least a few points in your life where you will require a large sum of cash relatively quickly. Perhaps you have emergency medical expenses, or want to do a home renovation. Perhaps you want to utilise the equity in your own home as a deposit for an investment property.

Whatever the reason, there will be times when borrowing money is inevitable. In this situation, if you have a reasonable level of equity in your home, you could consider a line of credit home loan.

What is a line of credit and how does it work?

A line of credit is an ongoing agreement between you and your bank which gives you access to a predetermined amount of credit whenever you need it. With a line of credit home loan, any money you borrow is usually secured against the equity in your home.

Say you borrow $300,000 from a bank to buy a home, with a deposit of $50,000. That means that at that point, your equity in the home is $50,000. Ten years later, your debt is down to $170,000 and your property has increased in value to $450,000. This means that all up, you now have around $280,000 equity in your home. Provided you meet the lending criteria of the financial institution, you may then be able to take out a loan against a proportion of the equity you have.

The most common type of home equity loan is the line of credit, which functions in a similar way to a credit card. You have a pre-approved credit limit and you can borrow as much of this sum as you want, with interest paid on the outstanding balance.

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Pros and cons of a line of credit

A big advantage of a line of credit is that, due to the fact that you’re using your property as security against the loan, you present a lower risk to the lender and will generally pay a lower interest rate then you would on other forms of debt.

Because your home is being used as equity though, it does mean that if your investments go south, or you manage the loan poorly, you could lose your equity and struggle to repay the loan. If things are really dire, you may even lose your house.

Whether a line of credit loan is appropriate can also depend on what the debt is being put towards and what the other debt option would be. Using a line of credit loan to consolidate credit card debt, for example, could end up being an expensive option if you do not pay off the loan in a timely manner.

Case Study: Louise consolidates credit card debt with a line of credit home loan

line of credit debt

Louise has accumulated $10,000 of credit card debt and is deciding whether to refinance the debt onto a 5 year personal loan at 9% interest, or add it to her line of credit (LOC) home loan at 5.5% interest. Here is the potential difference in repayments over 5 years:

Debt Interest Rate Monthly repayment Repayment over 5 years
Personal loan 9% $208 $12,455
LOC 5.50% $91 $11,461

Source: Canstar

In this situation, Louise would pay almost $1,000 less over the 5-year period by choosing a line of credit.

If, however, Louise was not disciplined about setting a timeframe for debt repayment (remembering that a line of credit can last indefinitely) and decided to pay the debt back via her line of credit over 10 years rather than 5, her total repayment could potentially become as follows:

Debt Interest Rate Monthly repayment Repayment over 5 years
LOC 5.50% $109 $13,023

Source: Canstar

In other words, if using a line of credit for personal debt consolidation, discipline is the key!

In summary, while a line of credit home loan can be a good way to access your equity, if you’re not confident in your ability to manage your finances and stay on top of an additional loan, it may not be the best debt option for you.

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