Lack discipline? Maybe you shouldn't apply for that line of credit

Lines of credit on home loans are a relatively new product in the mortgage marketplace.

But the problem is that it can be tempting for borrowers to use them as a cash machine that they never have to repay.

But, of course, that is not the case at all because lines of credit are not free money.

Property Investment Professionals of Australia chairman Ben Kingsley said lines of credit can have a role in the financial landscape but discipline was the name of the game.

“In the right hands, and for the right purposes, lines of credit have their place in the product suite of options available to consumers,” he said.

“But given lines of credit operate like a big credit card limit, they have the potential to be misused by some borrowers.

“So it’s important that any borrower be very disciplined about how they manage their money and they must always remind themselves ‘it’s not your money’ – it’s a loan that one day you will have to pay back.”

Lines of credit are a useful tool for sophisticated property investors, Kingsley said, who may use them to access equity to assist with funding their investment activities, such as helping to pay the deposit and various other buying costs.

Intuitive Finance managing director and mortgage broker Andrew Mirams said that lines of credit were sometimes more trouble than they were worth.

“People generally lack the financial discipline to maintain and reduce a line of credit,” he said.

“At the end of the day, a principal and interest loan with an offset account works exactly the same way, but at least you have minimum monthly principal reductions.”

He said other disadvantages of lines of credit can include paying a slightly higher interest rate due to the nature of the account being a fully operational transactional one.

Depending on the lender, and whether the line of credit is included under a professional package, establishment and ongoing administrative fees can sometimes be higher than for term loans, Mirams said.

“If you don’t manage your cash flow carefully, the compounding interest can also quickly erode your equity,” he said.

But a line of credit can be useful for people who need a financial buffer or who are looking to invest in shares, he said.

Investors running a property business also often used a line of credit as a transactional overdraft account, Mirams said, but they had to have the discipline to manage it correctly.

“Because there may be a temptation to access funds in a line of credit that aren’t necessarily going to build wealth, we generally suggest arranging one for disciplined investors looking to purchase a new property or to fund a renovation to an existing asset –  both options are generally likely to see you add value to your portfolio,” Mirams said.