Home Equity & Line of Credit Mortgages

What is a home equity loan?

At some point in many people’s lives, they’ll need a sudden – and sometimes rather large – cash injection. The money could be for a renovation, an investment property or maybe to help fund the purchase of a new car. One source of these funds could be the equity you’ve built up in your home.

A home equity loan allows you to borrow against the equity you have in your home to achieve another goal. The amount of equity you have in your home is the difference between the value of your property and the amount owing on your home loan. For example, if your property is worth $800,000 and you have $250,000 owing on your home loan, then you could have up to $550,000 in equity.

There are several equity home loan products on the market to Australian borrowers, so it’s a good idea to navigate the market and analyse product features to determine if they are right for you and your financial position.

Utilising a home equity loan

Typically when it comes to home equity loans, interest rates are generally lower than other types of credit, such as credit cards or personal loans. This is due to the fact that you are taking advantage of your home equity, and historically default rates on home loans are low – “as safe as houses” as they say.

This means a home equity loan can potentially help you save money, for example, if you’re looking to buy a car or pay out other types of debts with higher interest rates. The most common uses of home equity loans as mentioned above include:

• Home renovations: You can use a home equity loan to finance improvements, which may increase the value of a property or create more equity.
• Investing: If you’re looking to build your portfolio, you can use a home equity loan to help fund the deposit for an investment property.
• Lifestyle uses: Home equity could also be used to finance large purchases, such as a new car, or to establish your own business.

Home equity loan advantages and disadvantages

Advantages

• Lower rates: Home loan interest rates are generally going to be lower than those associated with other types of credit products, like personal loans or credit cards. This is because the property you’re borrowing against provides the lender with a high level of security.
• Flexibility: With a home equity loan, the funds can be utilised for almost any purpose providing you with flexibility that may not be achieved with another form of loan.

Disadvantages

• Increased debt: Unlocking your property equity will increase the amount you owe the bank. This generally will mean higher mortgage repayments that could potentially take longer to pay back.
• Transaction fees: There may be a number of fees associated with opening the new home loan, as well as exiting your existing home loan. It’s important before putting pen to paper on a home equity loan to consult a financial expert to determine a solution best tailored to your circumstances.
• Home prices could fall: Despite historically strong home price growth in Australia, home prices can and do fall. This could eat into your equity, theoretically making it possible to owe more on the new loan than what you have in equity.

Line of credit home loan

While a home equity loan is usually paid out to you in one lump sum, a line of credit home loan is more like a credit card in that you can borrow up to a pre–determined amount of money as and when you need it. You’re constantly paying off the line of credit home loan, which means you’re able to ‘borrow again’ when the need arises. This line of credit home loan is also secured against your equity.

Utilising a line of credit home loan

Typically a line of credit home loan is tailored more so to investment purposes and necessary expenses. This is due to the fact that the full flexibility of a line of credit home loan is only needed by some borrowers, while the potential risks may make this arrangement unsuitable for some.

Line of credit home loans may potentially suit investors looking to have an extra amount of funds on standby to invest in another opportunity or people looking to pay for renovations such as landscaping or cosmetic repairs where there is no fixed cost or budget.

Obtaining a line of credit home loan

If you’re applying to a lender for a line of credit on your home loan then you’ll need to fulfil the lender’s criteria in order to get the ball rolling. You’ll typically be required to supply:

• The name and address of each person borrowing.
• The employment and income of each borrower.
• The outstanding balance on the mortgage as well as the monthly payment.
• The current estimated market value of the property.
• Identification of each borrower.
• The amount you want to borrow.

Line of credit home loan advantages and disadvantages

Advantages

• Secure loan: A line of credit home loan is secured against your property. This allows for line of credit borrowers to typically be deemed low risk by the lender, resulting in a lower interest rate when compared to a personal loan or a credit card.
• Lower repayments: Line of credit home loans are in most cases interest-only, meaning your repayments are lower than a principal and interest loan with the same interest rate.

Disadvantages

• Potential to lose equity: If you mismanage the loan, or you use the loan for investment purposes and things go wrong, you’ll lose that equity and you may struggle to repay the loan. In the worst–case scenario, you could lose the property.
• Greater interest expense: If you are utilising a line of equity home loan to repay another debt, then you could end up paying more in interest in the long run simply because the line of credit may just carry on revolving.

Comparing regular loans and line of credit home loans

Looking for the best home equity (LOC) loans is different from searching for “regular” mortgages.

Interest rates on lines of credit are typically higher than on a regular mortgage. You need to factor this into your overall consideration.

The maximum amount that you can borrow is another vital consideration. Many lenders have relatively low maximum amounts – up to 80% of your property value, while some offer up to 95% if you have enough equity with the addition of Lender’s Mortgage Insurance (LMI).

How much could I borrow?

To determine how much you may be able to borrow, take advantage of Infochoice’s borrowing power calculator to get an indication. It’s important to try to keep the amount realistic so that you’re more likely to be approved for the loan. By keeping your potential loan goals realistic, this can mean you don’t have to wind up paying more than you really need or want to. Just because you can, doesn’t mean you should.