A Line of Credit (often abbreviated to ‘LOC’) is a variable rate loan facility which is secured by a mortgage over a residential property and has an approved limit that you can draw up to (not unlike a credit card but bigger).
In practical terms, you can access the funds available under a LOC as you need to.
The interest rate is usually variable and repayments are interest only and capitalize normally to the facility itself rather than having to make payments.
The key advantages of an LOC are:
- You can use the money when you need it and pay it back when you can.
- The LOC can provide you with a financial buffer to better manage your personal investment business. It’s like your own working capital just like a business would use.
- An LOC is flexible and the funds are available for multiple uses. However, we always recommend keeping personal use – such as a holiday or car, separate to use for business or investment purposes so you don’t “blend” the debts and make it difficult to ascertain your true expenses come tax time.
- Interest is payable only on the funds drawn and it is possible with some LOC’s to capitalise the interest which means that repayments won’t be required until the facility has been fully drawn – a great way to preserve your cash flow position.
- Funds can generally be readily accessible via debit card, cheque, internet or phone banking.
- Rates are lower than those on both personal loans or credit card as the facility is secured by residential property.
- Can be used in conjunction with other facilities or “split” to best use your equity.
There are always disadvantages with any facility, here are a few specific to LOC’s:
- Unless care is shown it is possible to reduce the equity you have built in your home by using the LOC to fund investments or purchases that don’t improve your financial position. We rarely recommend the use of these for a homer purchase rather preferring a home loan with an offset account.
- Sometimes you may be paying a slightly higher interest rate due to the nature of the account being a fully operational transactional account.
- Depending upon the lender and whether or not the line of credit is included under a professional package, establishment and ongoing administrative fees can sometimes be higher than for term loans.
- If you don’t manage your cash flow carefully, the compounding interest can quickly erode your equity.
Because there may be a temptation to access funds in a LOC that aren’t necessarily going to build wealth, we generally suggest arranging a line of credit for disciplined investors looking to purchase a new property or fund a renovation to an existing asset – both options are generally likely to see you add value to your portfolio.
If you’re a business owner with a mortgage against either your home or the property your business utilises then lines of credit can be very handy to help manage cashflow and should also mean that the interest charged is tax deductible (as always, consult your accountant before establishing any finance facility).