August 14, 2017
A home loan product can be categorised into four main types:
- basic variable loan
- standard variable loan
- fixed rate loan
- line of credit (LOC)
A line of credit, commonly marketing as Equity or Portfolio loans, is often overlooked by borrowers as a lending option. LOC's distinguishing features are:
- Most flexible product with no mandatory repayment unless the credit limit has been reached. In contrast, other loan products require minimal monthly repayment based on the original loan amount, not the outstanding balance.
- No defined loan term on principal repayment i.e. one could in theory not make any repayment for life. In contrast, other loan products have a maximum 30 years loan term to repay the principal.
- The loan account is suitable for everyday use. Salary credits, direct credit/debit, ATMs withdrawals and all features of an everyday account can be organized via a LOC account. In contrast, most loan accounts do not allow for ATMs withdrawals. Additional payment made in the loan account for variable loans have to be transferred to an everyday account before it can be used.
LOC borrowers usually put all income into the LOC facility. The theory is that you deposit your entire salary into the line of credit facility and draw back money for day to day living expenses. This reduces the daily interest charged. This benefit can be replicated by a standard variable loan with 100% offset facility.
LOC's benefits can be maximised by combining the loan with an interest-free credit card. By using this credit card for living expenses during the month, the balance of the home loan is reduced for the most part of the month. This arrangement minimises the accruing of interest because interest on a home loan is compounded daily.
With instant access to a pre-approved overdraft facility, funds can also be used to replace personal finances including margin, personal or non-factory sponsored car loans which almost always have a higher interest rate. Whilst this may not necessarily be sanctioned by lenders, some small business owners use LOC to replace business or commercial loans, providing further savings.
LOC is historically more expensive. This may no longer be the case with virtually all lenders charging a premium for investment and loans on interest-only repayment. Suncorp, for example, has an Access Equity Investment Line of Credit at 4.47% with a maximum lending ratio of 90%.
With no minimum monthly repayment and defined repayment terms, LOC may be suitable for:
- borrowers with irregular income e.g. self-employed, contractors or salespersons on commissions
- couples who plan to take a “repayment holiday” in future when the baby arrives
- the over 55s nearing retirement where it may be difficult to secure a mortgage post retirement
- property investors with remaining owner occupied home loan. The strategy is to opt for LOC for the investment mortgage and allow interest to be capitalised i.e. not make repayment. The purpose is to focus on repaying the owner occupied mortgage which is not tax-deductible
- shareholders replacing margin loans with LOC to invest in the share market. LOC is cheaper than a margin loan and offer a higher lending ratio
The interest rate is not everything. Make sure you are getting the right features in your home loan.