A line of credit (or a home equity loan) allows you to borrow money using the equity in your property.
Equity is the value of your home minus any money you owe on it. If your home is worth $700,000 and you owe $400,000 on your mortgage, then your equity is $300,000. Using a home equity loan, you can access some of that money (up to 80% of the property's total value) to spend on anything you want.
But are there any limits or guidelines about how you spend the money? And are there any risks?
When you access money through a line of credit, it means you are withdrawing money from your home loan based on the amount of equity you have built up in the home. The equity in your home is the amount of property you own, which is based on the property value minus the amount of debt you have left.
You can take out a line of credit and spend it on anything you like, from home renovations, a holiday or car, to even funding another property purchase or investment.
Note: The property value is based on the current value, not the value when you bought it. So, if your property value has increased since you purchased it, you have even more equity to access!
Most lenders will lend you up to 80% of your property's value. Some will go up to 90% or even 95%, but an 80% limit is far more common.
So, assuming you're going to a lender that offers 80% of your property's value, you can work out how much equity you could borrow using this formula:
(Property value x 80% LVR) - existing debt.
Example:
The amount you would access through your line of credit = $160,000
You only need to repay the amount you actually spend, not the total line of credit that the lender extends to you.
If you have a $200,000 line of credit and you spent $30,000 on a car, you would only pay interest on the $30,000, not the full $200,000.
Investors can use their equity to buy an investment property. For example, if your property is worth $500,000 and your mortgage balance is $200,000, then you have $300,000 worth of equity. This is a substantial amount of money that can be used to fund the purchase of another property or invest in other assets, such as shares.
There are a few potential costs of a line of credit loan:
With many line of credit home loans, you don't have to make monthly or regular repayments. This gives you more flexibility. In many cases, you don't have to make repayments until you reach your credit limit.
Line of credit home loans are often interest only for the first few years, meaning you pay the interest charges now and repay the borrowed amount later.
This keeps your costs down, but if you continue doing this for a long time it could cost you a lot in interest.
There are many benefits to withdrawing your equity if you need it, but any borrowing situation comes with risks that you need to know.
Comparing home equity loans is a little different to comparing traditional mortgages. You need to look at:
If you're interested in applying for a line of credit equity loan, it's important to speak to your lender or mortgage broker. While you can get a line of credit from your existing home loan lender, you may be better off refinancing to a new one. Get an idea of what your existing has to offer and then compare with the lenders in the above table.
When you're applying for a line of credit you may need to satisfy the following criteria or supply the following information:
You can save money on the interest payable over the life of your loan by using your income to offset the loan amount. This can be done by depositing your income into the loan account and then withdrawing money as needed to satisfy your living expenses from the line of credit. With this method, the interest on the loan is only calculated on the remaining balance of the account, which will lower your interest charges.
From a lender's point of view, it has the security of your home in the event you default on the loan. If your property declines in value, you will end up with less equity and you could even end up owing more on the loan than your home is actually worth. This is why it's a good idea not to borrow or use the full amount of equity available. Always leave a buffer.
Line of credit loans typically have much lower interest rates than personal loans. If you're disciplined in paying off your line of credit, you could potentially save thousands of dollars in interest. Let's look at an example.
| Line of credit | Personal loan | |
|---|---|---|
| Borrowing amount | $10,000 | $10,000 |
| Length | 5 years | 5 years |
| Rate | 5% | 14% |
| Monthly repayment | $188.71 | $235 |
Over the course of the personal loan, you would pay $4,117 in interest. With a line of credit rate, you'd pay $1,322.74 in interest. That's a saving of more than $2,794 over 5 years.
However, this requires the discipline to repay your line of credit loan in a timely manner. If you ended up letting your line of credit loan stay open for 15 years, you would end up paying $4,234.29 in interest, eclipsing the amount you would have paid on a personal loan.
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I’m currently semi retired, working part time and together with my allocated pensions and annuities my annual income is approx $60,000. I own my home which has a market value of #850,000. All credit cards both bank and store are paid in full each month. We own two cars. We currently have a Line of credit with the NAB which has a ceiling of $30,000.The LOC debt outstanding is approx $7500. The interest rate is 5.36%. We have no other debts. I’m seeking to increase the LOC ceiling to $50,000 and improve on the 5.36% interest rate. What advice can you offer?
Hi John,
Thanks for your question.
There are number of products on this page that is under the 5.36% p.a. mark. If you click on interest rate (p.a.) in the blue comparison table above, it will automatically sort the products into ascending order for you.
If you’d like to proceed with the new loan, you can speak to your new lender about what options you have paying out your current LOC.
I hope this helps,
Shirley
I’m looking at a 120,000 line of credit, have no mortage, house value 1.2Mil. I will draw down small amounts Buy car , hol etc, extra money into super over a 2 year period. We plan to sell the house 2018 pay off the Line of credit. I know you pay for what you use (interest) how does the lender determine what the Monhtly re-payments will be ???
Hi Greg,
Thanks for your question.
The monthly repayments are usually determined by the interest rate, applied to the outstanding balance. You can enter your borrowing amount into our blue table above, and it will generate the monthly repayments for you.
Cheers,
Shirley
my husband has a line of credit it is attached to an investment property, what happens if he dies, does it automatically come to me or does the line of credit become a mortgage?
Hi Sue,
Thanks for your question.
We have a good article called What happens to my home loan if I die? that can provide more information on this topic. Generally, the debt is handed over to the person closest to the borrower. As the article explains, there are some measures that you can take.
Hope this helps,
Shirley
Hi Sue-anne,
Thanks for the question.
We interviewed an expert from Slater & Gordon about this and wrote this guide – What happens to my home loan if I die?
I hope this helps,
Marc.
I have about $280 000 equity in my home and I would like to apply for a line of credit. I have no other loans apart from my mortgage and I have few expenses (only storage and health insurance). I don’t own a care and I have no dependents. I applied for a loan of $5000 from the bank with which I have my mortgage but they refused. The reason is that I am currently unemployed at the moment, but I have signed a contract to start a well paying job in December this year.
My question is: Can I apply at another bank even if I don’t have a bank account with them? I don’t even have a credit card because I am financially conservative, but when I applied for one at a different bank to my mortgage bank, I was refused again, because I am currently unemployed. If I can’t manage to get an equity line of credit from a bank, what are other options for me to get $5000 in the next month or so? I would really appreciate your advice.
Hi Justine,
Thanks for your question.
Currently being unemployed is a huge roadblock for any type of credit application, because most lenders like to see that you’re earning an income to pay back the loan you take out. Even though you intend to tap into your equity, lenders like to see that there is a supplementary income to reduce the risk exposure to them.
If you’d still like a line of credit home loan, you may want to get in touch with a mortgage broker. They’re home loan experts who can help you find the right loan for your situation.
Hope this helps,
Shirley
Ihave equity in my investment property which is currently tenanted.
The property is free of mortgage and I wish to take up a line of credit for $100,000
Please advice on interest rate
N. Jayram
Hello Jayram,
thanks for the question.
This will depend on the lender, so you may wish to compare the line of credit equity loans on offer and then enquire directly with the lender about what rates may apply to you.
I hope this helps,
Marc.