Line of credit home loans are expensive, old hat and not much use to most borrowers. Here’s why.
These days most of the functionality that’s traditionally been available with Line of Credit Home Loans is now built in to many standard variable loans.
Many modern “professional package” and standard variable home loans now allow you to do everything you can with a line of credit: you can go interest-only, pay extra, redraw as much as you want and create splits for free.
“The redraw and offset have made the line of credit obsolete,” says Heidi Armstrong, director of State Custodians Mortgage Company.
“The only difference is you can capitalise the interest, which is exactly the same as taking a repayment holiday,” says Armstrong.
“If you have one of our standard variable loans and you don’t make a monthly repayment we will sweep your redraw and write you a letter to say we’re doing so. With a line of credit the only difference is we don’t send the letter,” she says.
According to Armstrong, LoCs have been preferred by property investors because of the ability to capitalise interest but this is no longer relevant because the ATO has clearly stated that it won’t allow you to claim interest on your interest as an additional investment cost.
“Some line of credit loans are ever-green, they remain interest-only and never revert to principal and interest so you never have to repay the loan but State Custodians says you have to go back to principal and interest after 15 years.
“The only other reason to go for a LoC is if you want a cheque book,” she says.
Don’t get sold on an LoC
Armstrong says State Custodians doesn’t charge a higher interest rate on its LoC than on its standard variable home loan “but some banks do charge more so it’s time for people to stand back and not pay extra for it.
“The sell is that if you put all your money including wages into the LoC you’re decreasing the amount of principal you pay interest on but if you’re not making regular principal and interest payments and you draw all the money out again each month, use your credit card and it gets repaid from the LoC account, you can find that all your redraw is gone and you’re just really treading water.
“A LoC can be good for renovating if you want to pay your builder by cheque but now you can have the functionality to split standard variable loans and have your repayments calculated when you redraw.”
Choose a flexible standard variable
The feature Armstrong is referring to is “dynamic repayments” and it’s not available with every standard variable home loan so choose carefully. It works like this, if you build up a redraw balance by making extra repayments you can have your repayment adjusted so you’re only charged repayments on the amount of principal you owe. This means your repayments are lower but your loan will still continue for its full term.
Armstrong says some people prefer to keep their repayments the same irrespective of their redraw balance so they actually repay the whole loan earlier.
If you access your redraw and take money out of your mortgage (perhaps to pay that builder) your payments will be readjusted and will increase.
Some banks don’t allow you to have your repayments re-adjusted, no matter what your redraw balance, unless you have your loan re-amortised, which results in you losing access to your redraw balance.
“Some banks don’t have as much flexibility in their standard variable product as they could and this allows them to upsell customers who think they need that flexibility to a LoC with a higher rate,” she says.
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