Should you use a line of credit to buy a property?
The pros and cons of using a line of credit to purchase a property are often debated in the mortgage industry. When the real estate market is as hot as it is now in Australia, then the ability to strike fast and get a deal right down the line and make the difference that secures the home or saves thousands of dollars. dollars in potential price increases.
But the risks of a line of credit are always there, including the impact it can have on a credit rating 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 a fairly straightforward concept: Financial institutions allow a customer to access finance whenever they want, with a fixed amount always available to be withdrawn and interest charged as soon as it is accessed.
Banks typically extend this facility to customers they trust, whether businesses or individuals, and are more likely to extend it to those with a high credit rating based on a strong credit history. loan repayment.
If you have a credit card, you already have some form of line of credit borrowing because the upper limit on your card is basically a bank-issued line of credit 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 over a traditional mortgage tend to come down to how much money you already have and how much money you have already borrowed over the course of your life. life. If you are an experienced borrower who has developed years of trouble-free loan repayment, then a financial institution like a bank is much more likely to give you permanent access to finance.
The advantages of such an arrangement are obvious. You can access loans instantly without having to go through all of the processes that come with a regular application – that means no turnaround time, instant cash flow, and the ability to buy that property quickly before the price goes up.
As for the repayment, you are also already familiar with the interest terms, payment structure and monthly repayments, as all of this will have been agreed upon when extending the line of credit. This then allows the borrower to decide if the line of credit is the best form of financing they could get, or if it would be better to apply for a loan in the traditional way.
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What are the disadvantages of a line of credit?
The most obvious tradeoff is that while you can get quick and reliable access to finance, it can come at a cost. Your line of credit has a fixed interest rate that is likely higher than the current mortgage rate available in the open market. The rates are generally variable and this leads to the possibility that your repayments will increase over time from what they were when you bought the house.
The risk of that line of credit getting out of hand is always there too, which can lead to overspending, overwork, and negatively impacting your credit score. Having a huge amount of cash readily available is not something everyone can master, and it’s easy to spend first and think about repayments later.
What if I don’t use my line of credit?
In short, if you don’t use your line of credit, you don’t pay any interest on it because you aren’t using it. Think of it like a bank overdraft: you don’t start paying interest until you actually get it.
That said, you got the line of credit so you could use it, and it’s not really worth the hassle of asking 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 rating?
The biggest risk with a line of credit is its ability to get out of hand and therefore negatively impact your credit score. Granted, you’re likely only going to get a financial institution to give you credit if you’ve already built up a solid repayment history, but these previous loans were 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 repay the credit you accumulate. Again, it’s worth considering this as a credit card: if you buy something and then pay it off in an orderly fashion, then you’ll be fine and your bank will probably be more willing to increase your card limit. . If you don’t meet your obligations, expect the opposite to happen and your credit score to drop.
Should You Use a Line of Credit to Purchase a Home?
The pros and cons of a line of credit-style home loan basically boil down to efficiency.
Chances are, in today’s home loan rate environment, you will get a better mortgage rate by simply applying to a broker like everyone else rather than a line of credit. . Much of this is because the interest rates are so low and you have the option of getting a fixed rate, which you can refinance later if needed.
The benefits of a line of credit for buying a home come down to efficiency. If you are looking for a home today and have access to a line of credit to buy it without having to waste time negotiating a mortgage with a broker, then you can rush out and buy immediately. In an environment of real estate prices where prices go up to $ 10,000 per week, the difference between the higher interest rates on a line of credit is erased by the money you save by buying now rather than in a few. months, when the price may have increased further.