Very often you find yourself requiring cash to meet emergencies or for planned renovations or purchases. While it is always possible to use your credit card for smaller amounts or take a personal loan, using the equity in your house to fund further investments or home improvements can prove to be a much cheaper option if you maintain financial discipline.
What is a line of credit or home line?
Equity loans are most commonly in the form of line of credit (LoC) loans (also called home line) secured against the equity in your home. What this really means is the lender pre-approves you for a certain amount that you can withdraw as needed. Similar to a credit card with a much higher limit, a line of credit loan gives you approval for the usable equity amount, which you can withdraw in installments as and when required. The interest is charged only on the amount withdrawn. Equity loans are interest-only loans with no time limit in most cases and can be a ready source of cash in any kind of exigency.
How much can I borrow?
The amount of money you can borrow depends on how much equity you have built in your house. Equity is the difference between the amount you owe on your home loan and the value of your property as per the lenders. Getting an independent valuation to know your property’s worth always helps.
For example, Sue borrowed $400,000 for a home worth $500,000 a few years back. Today, she has paid $50,000 off the loan and the value of her home has increased to $550,000. Thus, she holds $200,000 equity in the property.
However, banks may not allow her to borrow this entire amount of $200,000. Lenders are generally comfortable lending up to 80% of the property’s value (90% if you pay LMI) and Sue’s useable equity, in this case, would be $90,000, derived by subtracting the outstanding loan amount from 80% of the property’s value.
Line of credit Vs. Conventional loan
A line of credit is considered a much more flexible option giving you access to reasonably large sums of money at lowest rates possible (mortgage rates are much lesser than interest rates on credit cards or personal loans).
Unlike a conventional loan, a line of credit is for a pre-approved amount that you may withdraw as a lumpsum or in installments, as required. The interest is payable only on the amount withdrawn. The loan is usually interest-only for a long period of time making repayments more manageable. Revolving line of credit loans mostly allow additional repayments and redraws at no cost (Do have these home loan features) meaning you can pay off your debt faster with financial discipline.
Advantages of a line of credit home loan
Apart from financial flexibility, a line of credit offers several benefits to investors and home owners:
1. A line of credit home loan gives you pre-approval for your maximum borrowing capacity, making cash readily available as and when required. However, refrain from using your line of credit just because you can.
2. Line of credit loans can be used to fund the home loan deposit on your investment property or even fund the renovations of your existing home, further increasing its value.
3. Many people use a line of credit home loan to reduce their repayments. As the loan is interest-only, you can pay the minimal amount every month and get by. However, it is best to make additional repayments as and when possible to reduce the principal as well.
Calculate your monthly repayments using this home loan calculator and maximise your repayments to be debt free sooner.
4. Rolling in your high interest rate debts in a line of credit home loan can affect significant savings if planned well. However, if you choose to refinance your high interest rate credit card debt in your line of credit loan and decide to pay it over the next 15 years, it may cost you dearer.
Should I or Should I not.
Using equity in your house to create a credit line is a more cost effective way of buying that car, renovating your home or taking that vacation if you can control the urge to splurge. As a line of credit mortgage gives you unlimited access to your funds, it is easy to borrow to the max and incur a large debt. Using an equity home loan for planned renovations or funding another investment will most probably add to your net worth, however, if things go awry, you may lose not only the equity, probably your house too.
Whether a line of credit fits your bill will eventually depend on your financial strategy and vision. In case you are planning to apply for a home loan, get the best home loan rates in the market through online mortgage rate comparison. Compare mortgage rates on HashChing for home loan deals and lowest broker pre-negotiated interest rates on home loans.