What is a home equity line of credit?
A Home equity line of credit is a revolving line of credit secured by a real-estate asset. A Line of Credit can represent your whole home loan if at the time of application your property is unencumbered, or it may form a part of your overall mortgage. The interest rate on a Home Equity Loan and payments on such a facility must remain variable because the borrower is allowed to draw moneys out and pay moneys into the line of credit as often as they wish.
A line of credit is like a credit card secured by your home or investment property. Most people use their credit lines only for major expenses such to finance home improvements, or pay off major debts. With a home equity line, you will be given access to a set amount of credit, but you only pay interest on the amount you access.
How Do I know How Much Equity I have in my Home?
This really quite simple. Your available equity is the difference between your current home value and your outstanding mortgage. If you have had your current home loan for a number of years without revaluing your property, you may find that you have a lot more free equity than you think. Some lenders in Australia are offering home loans at 100% and even 106% of the value of your home. These loans are offered on home purchases. For a mortgage refinance, most lenders will be happy to lend you up to 95% of the value of your home. To qualify for such a high LVR (Loan to Value Ratio) you must have a clean credit history and have adequate financials to support your loan application. You will still be able to obtain a Line of Credit against your home even if your financials are not up-to-date or if you have had some defaults in your history - however the LVR available to you will be slightly lower (perhaps 80% - 90%) and the interest rate charged on the loan may be slightly higher.
Lets assume that your home is worth $400,000 and your outstanding mortgage is $200,000. If this is the case, your current mortgage is up to 50% LVR of your home value. You should be able to obtain a Line of Credit to the value of $ 120,000, taking the total loan to $320,000 – ie. to 80% of the value of your home.
Why Should I Consider A Line of Credit?
The main advantage of a Line of Credit is that you decide when and how much you spend. You are only charged a home loan interest rate on the money you draw out. You are free to repay the moneys drawn at any point in time. While a Line of Credit can be used for anything from a car loan to an overseas holiday or home renovations, education expenses, further investment etc., one of the best uses for this facility is Debt Consolidation. By using some of your line of credit to repay all your other unsecured debts, you will see yourself paying around 7% interest on these debts instead of 15-20%. Therein lies a major saving allowing you to reduce your monthly obligations and pay off your mortgage faster.
What are the main advantages of a home equity line of credit?
The primary advantages from a home equity line of credit are lower monthly payments, because you only need to cover the interest expense on the money drawn out. The other benefit with an equity line of credit, is that the interest rate is lower in most cases than the credit card rate. Your financial position may change between the time that you apply for your initial home loan and some years down the track. By incorporating a Line of Credit into your Mortgage you may find that this line of credit will help you to make your mortgage repayments if you:
-loose your job;
- suddenly get sick and are unable to work for some months;
- need to take maternity/paternity leave and your income drops;
- have any other unexpected changes in personal circumstances.
In effect your Line of Credit acts as your 'emergency insurance'.
Are there any Disadvantages to a Home Equity Line of Credit?
There are no real disadvantages. However you do need to be disciplined to ensure that you do not go on a spending spree with your line of credit. As you are in effect using your home as security to pay your other debts, you must take extra care in ensuring that you do not 'overspend'. The risk of spending beyond your means is that you may lose your home. However this risk like all financial risks can be managed and should not prevent responsible adults from taking control of their financial future.
What if I wish to make principal payments?
You may make additional principal payments on your line of credit whenever you wish.
Will I need to Pay Penalties for early repayment?
In general terms your line of credit can be drawn and repaid at will without any penalties. You will however need to consult your chosen lender to determine what fees and charges will apply with your loan.
For more information on a Line of Credit or Home Equity Loan please visit
Maya Pavlovski holds a Bachelor of Commerce Degree from the University of Melbourne and is a qualified CPA
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