Line of Credit Home Loans
Line of credit home loans have often been promoted as a way to repay your home loan sooner, but do they really work?
The answer to this question really depends on how the line of credit it used. Used properly they can certainly be effective in repaying your loan sooner, but used incorrectly and they can actually have a negative impact.
What is a line of credit?
Before we go any further, let’s take a look at what a line of credit home loan actually is.
The easiest way to describe a line of credit is to think of it as a giant credit card. Not so much a giant plastic card, but a card with a giant limit!
Similar to a credit card, a line of credit gives you a certain limit that you can move up and down within. You can elect to repay the minimum repayment or you can elect to repay extra. You can also draw additional funds out of the facility provided that you are within your credit limit.
Unlike a traditional home loan, a line of credit does not have a fixed term. Just like a credit card you can continue to carry the debt for as long as you like provided that the minimum repayments are met each month.
A line of credit can also be used like a savings account, and in most cases you will have ATM and EFTPOS access to your line of credit.
Using a line of credit effectively
To use a line of credit (LOC) effectively you need to maximise the amount of money within your LOC at all times. This is done by following these steps:
- Have all wages and other income paid directly into the LOC
- Place any other available savings into the LOC
- Pay for all monthly expenses using an interest free credit card
- Repay the credit balance in full each month from the LOC
By following this process you will ensure that maximum funds are stored in the line of credit at all times. As interest is calculated daily, this will help to reduce your monthly interest bill and therefore allow you to repay your loan sooner.
A line of credit can still be used effectively even without a credit card. In this case you would still follow the usual steps, but instead of paying for everything on a credit card you would simply draw money from the line of credit using EFTPOS or ATMs etc.
The key is in maintaining the maximum amount of money within your line of credit at all times. An interest free credit card allows you to further maximise the benefit, but you can still obtain some benefit without one.
Line of credit traps
The potential traps with a line of credit are very similar to the traps with a credit card. The biggest trap is to repay the minimum repayment when you should in fact be paying as much as possible.
Another trap is continually maintaining your line of credit near its limit. Say for example you took out a standard home loan of $100,000 and had reduced it to $90,000 through the standard repayments, this amount would be locked in and your maximum loan balance would then be $90,000.
With a line of credit on the other hand you could increase the balance back to $100,000 at any time. You could work hard to reduce the balance to $90,000 then suddenly decide to draw $10,000 back out of the line of credit for a holiday or some other purpose.
For many Australians this can prove too tempting, and they can find themselves ten years down the track still owning the same amount of money on their mortgage that they started with.
A standard mortgage forces you to repay your loan within a certain timeframe, but a line of credit allows you to repay your loan over whatever period you like. Without discipline this can be a recipe for financial disaster for some.
Is a line of credit right for you?
To use a line of credit effectively you need to be committed to reducing your loan balance and have the necessary discipline.
With hard work and discipline there is no doubt that a line of credit can help to repay our loan sooner, but without that commitment you may be better off with a standard home loan. Compare line of credit home loans on Money Buddy today.