Line of credit home loans are one of the most flexible home loans on the market. A Line of credit home loan or equity loan, (as it is sometimes called) is a little like having a credit card. The limit is equivalent to the equity you have in your home. This could be hundreds of thousands of dollars. The Line of credit allows you to drawdown (take money out) and repay it whenever you like. Many lenders also allow you to attach a debit card to the account and use that to draw down whenever you like. With a Line of credit home loan, interest is charged on a monthly basis with no principal payment required. Many lenders will also allow you to capitalise the interest, so the interest just gets added to the loan every month and you pay nothing towards the loan at all. This may work for people in different situations, but be a disaster for others.
There are three main instances why you would get a Line of credit home loan. The Line of credit loan is principally used for investment purposes. Investors find the line of credit provides significant more flexibility than other loan types required for their investment strategy. Some home buyers however also use the line of credit for personal use to great affect to pay down their loan quicker than might be available with other line types. While business owners, can take advantage of money they have on hand in their business to reduce their interest on their home loan.
As an investor you really want to look at the type of investment strategies you will be using to decide on whether a Line of credit is appropriate for you. Are you looking to carry out debt recycling, where you will be needing to change the limits on a regular basis? Will you be needing multiple sub accounts? Then will you need to be creating additional sub accounts on an ongoing basis for each specific investment?. For example, you might decide to draw down $100,000 deposit required for an investment property purchase. Or you might establish a second sub account to invest $80,000 in a share portfolio. Will you require a Global Limit? (A global limit is a pre-approved borrowing limit, that allows your overall borrowings)
There are many different Line of credit options on the market but many of these do not actually provide a lot of flexibility. With some lenders once you set up the Line of credit you cannot make any changes to the structure of the loan without a complete new application. Other lenders will allow you to make as many changes as you like as long as you stick within a globally approved limit.
The great advantage of the Line of credit home loan for the personal borrower, is the ability to have every last cent sitting in your home loan reducing your daily interest bill. Many borrowers will put this strategy on steroids through the use of a 55 day interest free credit card, and then use a credit card auto sweep feature. You can essentially be using the banks funds at no cost to reduce the daily balance on your home loan. While this in theory can be a great strategy for the personal borrower, in practice it doesn't generally work near as well. The problem occurs because most people who use the credit card for their everyday spending, spend significantly more then they would otherwise. So while they might save interest using the banks money, all of this benefit and more is offset due to increased spending. This was a strategy that used to be recommended by a lot of financial advisers but they also found what can be great in theory can be very poor in practice. In reality, unless you are very disciplined with your spending the Line of credit home loan is not likely for you. Many lenders have also withdrawn their line of credit products and made it difficult to obtain with new APRA guidelines coming into force. Another option is to look at a standard variable loan with an offset account.
Small business owners can really use the line of credit to their advantage. Many business owners have money set aside for GST or other purposes, that generally sits in an account not doing anything. For a business owner that have a line of credit, this money can be used to reduce the amount of interest that they pay on their home loan. Another advantage of having a Line of credit for a business owner is the lower interest rates by borrowing through a home loan instead of using commercial loans. If there are irregular flows or long periods between payments then a Line of credit can help. However, as with a personal borrower, a close eye needs to keep watch, to ensure that the business is able to pay their different financial responsibilities.
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