The pros and cons of using a line of credit to buy property are often debated in the home loan business. When the property market is as hot as it currently is in Australia, then the ability to strike quickly and get a deal over the line and be the difference that secures the house or saves thousands in potential price rises.
But the risks of a line of credit are always there, most notably the impact that it can have on a credit score and the potential for higher rates, especially at times like these when rates are historically low.
What is a line of credit and how does it work?
A line of credit is quite a simple concept: financial institutions allow a client to access finance whenever they want, with a set amount always available to be tapped and interest drawn as soon as it is accessed.
Banks generally give this facility to clients that they trust, whether businesses or individuals, and are more likely to extend it to those who have a high credit score based on a solid track record of repaying loans.
If you have a credit card, you already have a form of line of credit borrowing, as the upper limit on your card is essentially a line of credit issued by the bank to you that you pay off in the form of the outstanding balance.
What is the benefit of having a line of credit?
The pros and cons of having a credit score as opposed to a traditional mortgage loan tend to come down to how much cash you already have, and how much money you have already borrowed over your life. If you are an experienced borrower who has developed years of loan repayments without problems, then a financial institution like a bank is far more likely to give you a permanent access to finance.
The benefits of such an arrangement are obvious. You can instantly access loans without having to go through all the processes that come with a regular application: that means no turnaround times, instant cash and the ability to buy that property quickly before the price rises.
In terms of paying it back, you also already know the arrangements with interest, payment structure and monthly repayments, as that will have all been agreed when the line of credit was extended. That then empowers the borrower to decide whether the credit line represents the best form of finance that they could get, or whether it might be better to apply for a loan in the traditional manner.
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What are the cons of a line of credit?
The most obvious trade off is that, while you might get quick, reliable access to finance, that might be at a cost. Your line of credit has a set interest rate that is likely higher than the current mortgage rate available on the open market, so you’d pay more over time than if you went to a broker and took out a stock standard home loan. The rates is generally a variable one and that brings with it the potential for your repayments to rise over time from what they were when you bought the home.
The potential for that credit line to get out of hand is always there, too, which can lead to overspending, overexertion and negative impact on your credit score. Having a huge amount of readily available cash isn’t something that everyone can stay on top of, and it is easy to spend first and think about the repayments later.
What happens if I don't use my line of credit?
In short, if you don’t use your line of credit then you don’t pay any interest on it, because you don’t run it up. Think of it like a bank overdraft: you only start paying interest on it when you actually dip into it.
That said, you got the line of credit so that you could use it, and it’s not really worth going to all the hassle of getting a bank to lend you money whenever you want if you don’t actually want to borrow.
Does a line of credit affect my credit score?
The biggest risk of a line of credit is the ability of it to get out of hand and thus negatively impact on your credit score. Granted, you’ll likely only get a financial institution to extend credit to you if you already have built up a solid repayment history, but those previous loans were based on a case-by-case basis.
The chances of your line of credit affecting your credit score are intrinsically linked to your ability to continually pay off the credit that you accrue. Again, it pays to think of it like a credit card: if you buy something and then pay it off in an orderly fashion, then everything will be fine and your bank will likely be more willing to raise the limit on your card. If you fail to meet obligations, then expect the opposite to happen and your credit score to fall.
Should you use a line of credit for property purchases?
The pros and cons of line of credit style borrowing for a home basically come down to efficiency.
The chances are that, in the current home loan rate environment, you’ll get a better mortgage loan rate by simply applying for one from a broker like everyone else rather than from a line of credit. This is largely because interest rates are so low, and because you have the option to get a fixed rate, which you can refinance down the line if required.
The benefits of a line of credit to buy a home come down to efficiency. If you’re looking at a place today, and have access to a line of credit to buy it without having to waste time on turning around a home loan with a broker, then you can swoop in and buy immediately. In an house price environment where prices are going up by as much as $10,000 a week, then the difference in higher interest rates on a line of credit is wiped out by the cash you save buying now rather than in a few months’ time, when the price might have shot up yet further.