Building home equity – the difference between your property’s value and what you still owe on it – means building wealth. It also provides you with options about what you can now do with that money should you choose to access it. You can take out a home equity loan and use it to make renovations, buy a car, go on holiday or buy an investment property.
Another option is a line of credit loan where you use the equity in your property to access funds when needed. With a line of credit loan, you can withdraw a pre-arranged amount of cash every month, which, depending on how the loan is structured, often only requires an interest-only repayment.
A line of credit is a revolving credit facility where you can withdraw one lump sum or regular amounts over time. 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. So it provides much greater flexibility if you require money for a specific purpose, such as a medical emergency, or if you’re strapped for cash.
Line of credit options
Most lenders in Australia offer a line of credit that you can access when you have achieved an appropriate level of equity, though each will have their own terms and conditions outlining the amount you can borrow. You can start by talking with your current lender about your line of credit options.
As with a home equity loan, most lenders will cap the amount you can borrow through a home equity line of credit at 80% of the property’s value. So if you borrowed $500,000 to buy a home and you owe $300,000, you have $200,000 in equity. But if the property is now worth $600,000, you have $300,000 in equity. However, the bank will require you to provide 20% of the property’s value from that equity, meaning you can access $300,000 minus $120,000 (the equivalent of a 20% deposit), leaving you with access to $180,000 to use as your line of credit.
With a line of credit, you can, as the name suggests, continue to borrow up to a limit, repay the amount and borrow again as often as you like throughout the term of your mortgage.It operates in a similar way to a credit card where you pay it back and borrow again.
In most instances, the line of credit will only need to be repaid by the end of the mortgage term but obviously paying the money back as soon as possible will reduce your interest repayment burden.
With line of credit loans, there are basically two options, principal and interest and interest-only. 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.
An interest-only line of credit does, by definition, mean lower repayments so you can use more of your equity on shares and other investments, or indeed a line of credit home loan for an investment property. Just be aware that this type of investing is accompanied by a level of risk that you’ll need to be comfortable with should your financial circumstances, especially regarding your income, change.
Differences between redraw, offset and home equity loans
Mortgages come with many facilities that allow you to make extra repayments and/or minimise the amount of interest you pay wherever possible.
A redraw facility allows you to pay extra amounts off your mortgage to build equity and then redraw the extra amount whenever your situation requires it. Unlike a home equity loan or a line of credit, a redraw facility only allows you to redraw the extra amounts you have paid into your mortgage, not access the full equity that may be available.
An offset account acts as an everyday transactional account linked to your mortgage where the balance is taken off the total amount owing, thereby reducing interest payments.
A line of credit, unlike a one-off home equity loan or the above facilities, acts as a more flexible transactional vehicle where you can access the funds whenever you need them for everything from an investment property to a car, other items, renovations or simply to pay down other debt if need be.
Pros and cons
A line of credit can be a useful tool if you need to access cash regularly, just as long as you’re wary of the pitfalls. Below is a list of the pros and cons and, as with all things property related, it is highly advisable that you speak to your current lender, a financial planner, or mortgage broker before making any decisions.
The pros include:
You have access to the money when you need it: A line of credit loan allows you to access your equity as needed. You are then free to use the money on anything you want, from an investment property to shares to a holiday, car, furniture or debt consolidation. It can also provide a buffer in the advent of an emergency.
Flexible repayment structure: Unlike other loans or your mortgage itself, you don’t have to pay back the line of credit in regular instalments. You just need to stay within your limit and pay it out at the end of the mortgage term. A line of credit, therefore, offers you the most flexible possible repayment structure.
You only pay interest on what you borrow: You can structure your line of credit so you only have to repay interest on the loan amount, freeing more money for investments if you’re confident they can provide a better return than you would get by paying off the mortgage.
The cons include:
Reduces the equity in your property: Using a line of credit will undo your hard work in building equity as the money borrowed goes back onto your mortgage and may add years to the time it takes to pay it off.
Usually higher interest rates than your mortgage interest rate: There are fees and charges associated with a line of credit and many lenders will charge higher interest rates than what you may currently be paying on your mortgage, so check with your lender first. The interest rate will still be less than it would be for a personal loan or a credit card, but you need to be aware of the premium you could be charged for this facility, nonetheless.
It requires discipline: Having a line of credit does require discipline so you don’t just end up spending money on things you don’t need and end up back at square one with your mortgage. This could also end up being particularly costly if interest rates continue to rise and your situation changes, in terms of your income, for example.
» MORE: Types of home loans