November 29, 2017
Line of Credit – How Relevant in Today’s Market?
In reviewing client’s personal balance sheets it is amazing how many people have a line of credit tucked away as an ongoing facility. Often it is for a relatively small amount of say $30,000 and is typically fully drawn and just the interest is being paid. It doesn’t cost a lot to manage and it is one of those “jobs to get around to” type items.
Line of Credit Background
Back in the late 1980’s and 1990’s lines of credit were really popular. The spin was that the borrowing couple refinance their principal and interest home loan to a line of credit, have the salaries paid directly into it and then take out a joint credit card that would be swept (ie fully paid by the line of credit) on a monthly basis. The couple would then be encouraged to take a 2nd and even 3rd line of credit to take the borrowing limits to 80% of the value of their property and these additional facilities would be used for investment purposes. This was typically for buying and selling shares and putting 10% down on an investment property.
The interest rate was only 0.10% pa above the home loan rate and the bankers had excel spreadsheets on hand showing clients that by paying their wages directly into the home loan and living off the credit card then they would save years off the life of the loan.
It actually worked for some people that were very disciplined with their spending and they used the equity in their homes to build up an investment portfolio of shares and property.
For many it was a complete disaster. The credit card took an absolute hammering and the additional lines of credit were used for holidays and new cars all on interest only. Some used the lines of credit for speculating on the sharemarket and again it usually didn’t end well. The outstanding balances on the lines of credit stayed at the limit and never moved down.
Fast Forward to Current Day
The line of credit appears to have had its day. Like the ATM and manual point of sale “clicker clackers” new products have come onto the market. A line of credit from a big 4 bank can cost 6.38% pa and this compares to a variable rate home loan of 3.64% pa. The 0.10% pa buffer has blown out to 2.74% pa.
So What Happened
The government regulators really do not like lines of credit as customers are not paying down debt and building wealth. The banks have to set aside funds at the limit even if you are well ahead. After all what if you had a limit of $300,000 but only drawn to $100,000 and you needed that additional $200,000 but the bank didn’t have the funds ready when you were.
Try searching for details on a line of credit on the bank’s web sites. They don’t make it easy and you will soon find that personal lines of credit are withdrawn as a product and old products converted to the new range. Lines of credit for investment purposes will survive but only at a premium interest rate.
What To Do Now
Make the time to call a mortgage broker and ask to refinance that old line of credit into a principal reducing home loan. The difference in interest rates will almost cover the difference in instalments and every fortnight or month you will gain precious equity in your property. If you take an offset account or have re-draw as an option you effectively still have a line of credit but at an much reduced interest rate.