Line of Credit Home Loans: What They Are & How They Differ From Other Loans
A line of credit home loan is an easy way for you to access your home equity without submitting an application every time you want to withdraw funds. It’s very similar to a home loan top up feature, but there are a few key differences.
In this guide, we’ll explain how a line of credit loan works, and how it differs from other home loans.
- A line of credit home loan is a revolving line of credit that allows you to access funds in your home equity.
- These loans have a flexible repayment schedule, allowing you to manage your own debt. The trade off for this flexibility is usually a slightly higher interest rate.
- Line of credit loans have a high credit limit, and you only pay interest on the funds that you use.
What is a Line of Credit Home Loan?
Line of credit loans are a revolving line of credit secured against your home equity. In fact, these loans are sometimes referred to as home equity loans.
Your home equity is calculated by subtracting your mortgage debt from your home’s value. So if your home is worth $400,000, and you have $200,000 remaining on your mortgage, your home equity is $200,000.
Home equity can go up if your house appreciates in value. It also increases as you pay down your loan and owe less on the property. Though it seems like an intangible concept, equity can be quite valuable to homeowners.
You can access the equity in your home through a line of credit loan. With this loan, borrowers get an approved borrowing limit – much like a credit card – except that the line of credit limit tends to be much higher.
When your loan is set up, you’ll be able to draw down funds up to your credit limit whenever you need to, repay them at your discretion, and draw the funds down again. There are some rules about repayments, which we’ll explain shortly.
Funds are drawn and deposited much in the same way that you withdraw funds from a regular transaction account, making it easy to manage. In fact, some line of credit loans come with a debit card for accessing the money, so you can use it for regular purchases.
Line of credit home loans are available to owner-occupiers and investors.
Line of Credit Loan Repayments
Part of the appeal of a line of credit loan is the flexibility of repayment. Most line of credit loans are interest only (unless you elect for a principal + interest repayment structure). In this case, you won’t have to pay back the principal of the loan – only the interest charges and any applicable fees.
Some line of credit loans require you to pay back a small percentage of your balance each month, or a set amount.
This flexible repayment structure means it’s up to you to manage your debt. In theory, your principal loan amount could be outstanding for years as long as you maintain the fees and interest.
Any principal owing on your loan amount is deducted from the equity of your home. You won’t be able to own your home free and clear until the full amount is paid. However, this may not be a problem during the life of your loan as you pay down the mortgage.
With line of credit home loans, you are able to make additional repayments at any time without consequence, so you can pay it down as quickly as you like.
What’s the Difference Between a Line of Credit Loan and Other Loans?
Understanding the difference between a line of credit loan and other loans can be confusing, especially when compared with a top up home loan.
With a standard fixed or variable rate home loan, you’re borrowing a fixed amount of money in order to purchase a house. You pay your lender back over the loan term until the loan is paid in full, at which time you assume full ownership of the property.
Some standard home loans have a redraw facility. You can make extra repayments during the life of your loan, which can then be redrawn and used at your discretion. Some redraw facilities have a maximum withdrawal amount while others are unlimited and fees may apply dependant on your lender and the type of loan.
Other loans (usually variable home loans with a comprehensive set of features) come with the option to top up your home loan. In this case, your loan account does not change, but the amount does.
With a top up loan, you’re using the equity in your home to increase the amount of your home loan. You will only pay interest on the funds once they are drawn down.
A line of credit loan is an ongoing, revolving line of credit. With a top up loan you have to apply for the top up each time, and your lender may impose a limit on the number of times you can do this.
With a line of credit loan, you can draw down funds whenever you want, up to the preapproved credit limit. This means you don’t have to know exactly how much you need to borrow at the beginning, but can go back and draw down more as you go.
There is a greater element of independence with a line of credit loan, but also more responsibility. Line of credit loans often have their own interest rate, which may be higher than the standard variable rate.
Why Get a Line of Credit Loan?
There are many reasons you might get a line of credit loan. It’s a handy loan to have if you need cash in a hurry, or if you’re not sure exactly how much you need to borrow.
People use funds from a line of credit loan to do things such as:
- Put down a deposit on an investment property
- Pay for large or unexpected expenses, such as higher education or medical bills
- Remodel an existing property
- Buy a new car or appliance
- Take a long-overdue family holiday
There may be restrictions on the types of things you can purchase with funds from the loan. For example, you may not be able to use the funds for business expenses, construction loans or bridging loans.
What are the Interest Rates on a Line of Credit Loan?
The trade off for the flexibility of a line of credit loan is a higher interest rate; but remember that you’re only paying interest on what you use. However, some lenders offer discounts on their advertised rate based on the total amount of your home loan and whether or not you are a member of their home loan package.
Pros and Cons of a Line of Credit Loan
So, is a line of credit loan for you? It’s an individual decision that depends on your financial situation, cash flow needs and spending habits.
Let’s take one final look at the pros and cons of a line of credit loan.
Still not sure if a line of credit loan is for you? Compare home loans to see what your options are.