Banks discourage borrowers from choosing a line of credit loans because they deem them to be a risk. Due to this, the decline of line of credit loans has been in the forefront of the news.
A Line of credit is a method to borrow money using the equity in your property. Most lenders used to offer clients up to 80% of the property’s value, or even go up to 95% on a case by case basis.
You could use it to nibble away the funds to pay for small home-improvement projects or you could use them to fund another property purchase.
Why do banks hate line of credit?
Banks and lenders hate line of credit loans. Even when banks or specialist lenders provide a line of credit, they do so with more stringent approval requirements than applied to a regular home loan.
There are many reasons why banks/lenders favor a standard home loan over a line of credit loan :
- The borrower might use the borrowed amount for an insignificant purchase on a whim, and the bank may have to bear the brunt of the risk.
- Banks can only charge fees if the borrower withdraws money from the line of credit, and there’s a chance that the borrower won’t use it.
- Line of credit has a higher risk and less margin of profit for investors, making banks stay away as much as possible.
- Line of credit loans have a thinner margin but carry the exact admin cost as a standard loan; hence the bank is less profited.
- As the line of credit works as overdraft that lenders have no control over the usage of funds. So, lenders do not wish to encourage borrowers to spend on excessive lifestyle.
Pros and cons of line of credit
- There is no set loan term and you can borrow money up to a certain limit similar to a credit card and then make repayments on an ongoing basis.
- With a line of credit home loan, you can withdraw large sums of money with ease and flexibility.
- You can access lower interest rates compared to personal loans or credit cards.
- You will pay interest only on the amount you draw down from the line of credit.
- You have the option to get a line of credit and then use it to increase the value of your home through renovations.
- Line of credit home loans are usually interest only for the first few years, which means you can pay the interest charges now and repay the borrowed amount later.
- Some lenders allow you to capitalise interest on the loan balance, hence no contractual repayment is required as long as your loan balance is under limit.
- A line of credit loan is risky for the borrower because their home will be kept as a collateral and they may lose their home in case of foreclosure.
- A line of credit is attached to variable rates, which can move up and down without warning.
- When the economy fluctuates, a line of credit is liable to be frozen by the banks in a downturn.
- A line of credit is hard to get against non-owner occupied properties.
- You might fall under a great risk if you have poor financial discipline.
- Line of credit loans attract a higher interest rate than a standard loan, so it requires stronger borrowing power to qualify.
Are there other options?
Home equity loan:
A home equity loan is much like a traditional mortgage loan in which you’re given a big sum all at once based on the equity of your home, rather than a line of credit where you can redraw small amounts whenever you require.
With home equity loans, you will have to pay back the loan balance in monthly repayments across your loan term, which usually ranges from 5 to 30 years.
If you have to deal with a big expense, then home equity loans can be a smart choice in getting access to a large amount of cash at once.
You can also consider a cash-out refinance if you’re set on tapping into your home equity.
A cash-out refinance allows you to switch your current mortgage loan balance with a new and larger loan.
You’re not adding a second payment with cash-out refinance. Instead, you’re replacing your current loan payment with a new one.
The new loan might be higher or lower or the same as your old one; it all depends on the loan term, interest rates, and total loan balance.
Hence, cash-out refinancing can be a great choice because it keeps you to one mortgage payment per month and gives you a large lump sum to use however you see fit.
Personal loans have a loan term between one and seven years. The loan must be repaid by the end of the term.
It can be a good option for someone who doesn’t want to get a line of credit home loan.
Even though personal loans might have higher interest rates, they have the flexibility of both fixed or variable rates.
Do you need our help?
Please fill our free assessment form or call us on 1300 899 743 to talk to a mortgage broker who is able to assist you and give you expert advice on a line of credit home loan.