It sounds tempting to use the equity in your home to fund the purchase of your new car, but does a line of credit take you down a slippery slope?
How does a line of credit work?
A line of credit (LOC) involves drawing out some of the existing equity from your home to fund other expenses such as a renovation or buying stocks, and then paying the amount back into your home loan later. The lender will set your credit limit according to how much equity you currently have in your home.
The interest rate attached to a line of credit home loan is normally higher than that of a standard variable loan – so you’re paying for the extra flexibility it provides. It works like a really big credit card, and you have to make interest-only repayments.
The proportion of borrowers who take out a line of credit mortgage has steadily declined since December 2010, to 6.6% last month.
Who it’s great for… and who should stay away
For the big spenders, a line of credit offers big advantages: you have easy access to funds; you have a higher credit limit than on a standard credit card; and you can consolidate your other loans
at a home loan rate (which is typically lower than the rates charged for a car or personal loan).
Debbie Worthington from Mortgage Choice says banks market lines of credit as a way to pay off a home loan faster, but she often sees customers who have fallen into the trap of making no progress in paying off their mortgage.
Those customers can actually increase their level of debt and usually end up having to refinance their loan. She says first-home buyers should generally speaking avoid using a line of credit, as they will be less likely to be able to budget well.
Lines of credit work best for those who can strictly manage their spending and are good at budgeting. “If you take out a line of credit, my advice is to continue to pay off your principal amount monthly and pretend you no longer have repeated access to the equity in your home,” Worthington says.
To work out which line-of-credit mortgage might be best for you, visit yourmortgage.com.au
and click on ‘Mortgage Chooser’.
-- By Stephanie Hanna
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