A home equity loan, or line-of-credit loan (LOC), is a facility set up so that you can draw down as much money as you need up to a certain limit that’s been agreed with your loan provider. You need to make interest only payments on the balance of the equity loan, but you do not need to pay off the principal amount.
This type of loan is often secured against your PPOR (principle place of residence or your home that you live in). It is typically used to access equity in your home for spending on lifestyle expenses or for further investing.
How it Works
Say you have a home that you live in worth $500,000 with a mortgage of $300,000. This represents an LVR of 60%. The bank might say that they are happy for you to refinance back to 80% which means you have $100,000 of borrowings available.
So you apply for an equity loan of $100,000 which takes your total borrowings up to $400,000 which is 80% of the property value (LVR = 80%).
You now can use that $100,000 limit much like a credit card and some LOC loans will come with a VISA debit or appropriate access card. Just like a credit card, you don’t need to go out and spend your full limit all at once! You can decide to maybe just draw down $20,000 for a new car and leave the rest there for future expenses such as a holiday.
You will only be charged interest on the $20,000 balance, not the total $100k loan limit.
Let’s say, you then sold off an old caravan and you had a spare $10,000. You could throw this back into the equity loan and reduce the balance back down to cut your interest bill.
This shows the flexibility of an equity loan compared with a normal home loan.
Be Careful How You Use the Funds
You need to be careful how you use the funds from an equity loan because you do not want to use some for lifestyle expenses (such as buying a car or furniture) and some for investing. Choose one or the other because if you want to claim interest deductions for investing purposes, you do not want lifestyle expenses mixed into the equation.
Keep them both separate.
As you can see, equity loans offer great flexibility with your borrowings and allow you to access that built up equity in your home to help fund your lifestyle or investment portfolio. Understanding how an equity loan works will help you use it wisely.
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