How does a line of credit work?

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

When you own property and continue to pay off your mortgage incrementally you, in turn, will 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. Also known as an equity line, a line of credit is a bit like having a really big cheque book that also charges you interest on the balance. It 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 have already built in your home as collateral is effective as home loan rates are typically the lowest interest rates available. When using the equity of your home as a line of credit, this takes you longer to own your home. However, this is not necessarily a bad thing. If you are directing the line of credit loan towards another investment, such as a new property which can earn you a decent return, you are likely to increase your net worth and in turn, your overall wealth over time.

If you are looking to pay off your mortgage fast, a line of credit loan is often cited as a complementary tool by directing income from all sources into your line of credit account. You can then draw your living expenses from the account as and when required. If you do choose this route, you will want to ensure you have spending restraints in place so you do not end up drawing out more money for living expenses than you have 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, this type of loan is best suited for home buyers 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.

Nonetheless, there are unparalleled 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? 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.