How does a line of credit work?

A line of credit loan is an excellent option for those that are already homeowners and are looking to buy another home or investment property.

When you own property, as you continue to pay off your mortgage incrementally you, in turn, gain further equity in your home. With this accumulated equity, you have the opportunity to be able to take out a loan against a proportion of the equity you have in your current home.

While there are many types of home loans, the most common type of home equity loan is the line of credit. A line of credit is a bit like having a really big cheque book that also charges you interest on the balance. A line of credit, also known as an equity line, is a useful resource if you have already built up a reasonable amount of equity in your home as you can harness that equity to purchase other assets, such as a new home.

Using the equity, you’ve already built in your home as collateral is effective as typically home loan rates are the lowest interest rates available. In using the equity of your home as a line of credit this takes you longer to own your home. However, this isn’t always a bad thing. If you’re using the line of credit loan towards another investment, such as a new property, which can earn you a decent return, you may, over time, be likely to increase your net worth and increase your overall wealth.

If you are looking to try to pay off your mortgage fast, a line of credit loan is often cited as a tool to help you do this by directing income from all sources into your line of credit account, which you can, in turn, then draw your living expenses from as and when required. Be warned though, if you do choose this route you’ll want to ensure you have spending restraints in place so you don’t end up drawing out more money for living expenses than you’ve put in which would result in more debt and often higher interest rates!

Who is best suited for a line of credit loan?

As a line of credit is akin to having a virtually unlimited cheque book it is suggested that this type of loan is best suited for homebuyers who are extremely disciplined when it comes to managing their finances. If you tend to be an over-spender or impulse buyer, then having a line of credit can be a trap

However, there are also many benefits to a line of credit loan. With this type of loan, you have great flexibility in managing the size and timing of your repayments which enables you to access additional funds and even take your current mortgage with you to another home. Line of credit loans also often save you interest. How, you might ask? Because your entire income typically goes into your line of credit account and stays in your account until you need it, this means that a large portion of your income should stay in your account longer, thus saving you interest.