Line of credit home loans - investment tool or infinite debt?
by Andrew Willink
9 July 2008
If you’re like most people, you’ve probably never heard of a revolving line of credit home loan, or are unsure of what it is. Line of credit loans have been getting a bit more attention lately, especially since the credit crunch hit home owners right where it hurts. That is, their ability to make the minimum monthly repayments. A line of credit loan doesn’t have set minimum repayments, so it may seem like a dream come true to those who are doing it tough.
However, as we are often told, if it sounds too good to be true, it probably is! So what is a line of credit home loan and how do they work? Essentially, a line of credit loan is an overdraft which allows you keep your cashflow from being tied up. At some point, the entire loan amount must be paid back, but with no minimum monthly repayments it is easy to forget that fact. Once the dollar limit on the line of credit is reached, repayments are then required. The risk is that you could create a loan that never dies and end up paying back far more than you ever would have if you had taken out a standard home loan.
A line of credit is technically an interest only loan, however most people pay back interest and principal repayments since this is the only way to minimise the amount of interest you end up paying to the lender. Many lenders market the product as a "lifetime loan" since it can be used in the place of several different loans and you may never need to take out another loan. For example, it could be used to buy a house, a new car and shares. But only if there is sufficient credit remaining on the loan. Once the credit limit is reached, repayments must be made.
Line of credit loans often have a higher interest rate than ordinary variable loans and those that aren’t good at budgeting for regular repayments could be caught out. Line of credit loans are really designed for investors seeking to maximise cash flows and tax benefits.
Discipline is the key to managing a revolving line of credit loan. If you’re not the type to be able to stick to a budget and make repayments on a regular basis, a line of credit is probably not for you. With a line of credit loan there is the very real danger that when combined with little or no repayments the loan could end up being debt that never dies, or at the very least causes you a lot of grief in trying to make repayments to cover the interest and principal.
For investors who have the funds and discipline to use it effectively, a line of credit can bring many benefits. But before you sign up, be sure to do your research and compare loans. Interest rates, fees and features can vary widely across lenders. Also it is important to seek advice from a financial planner to determine if a line of credit is best for you.
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