What are lines of credit and offset accounts?

We’re often approached by clients who have a story along the following lines; "We bought our house a few years ago, we’ve paid down some of our home loan, and now that we’re in a better position we’re thinking of buying an investment property. Can you help us figure out the best way to arrange that?"

As part of an investment property purchase, you will almost certainly need to provide a deposit from your funds. The exception to this is when cross-collateralisation is done – which is covered in our earlier blog post here. Additionally, it’s a good idea to have a financial/cash buffer in place in order to help you manage any large or sudden property-related expenses, such as urgent repairs.

Releasing equity from your home typically involves a valuation of the home. In order to determine the equity that is actually available, banks will generally allow total lending of up to 80% of the property’s value where this is involved, but keep in mind that there is already a home loan in place that accounts for part of that 80%. In addition to this, various lenders, including the current lender, should be researched in order to confirm that a) the proposed new loan is affordable and acceptable to the lender, b) that the chosen lender is offering loan products that are as competitive as possible.

This then leads to a loan application to request the establishment of one of two new facilities – a line of credit or an investment home loan with an offset account.

A line of credit is a fully transactional revolving credit facility. There is an approved limit for this facility, no set loan term or monthly repayments or direct debit arrangement (unlike a regular home loan), and transactions can be made into and out of the account without much hassle, so long as the approved limit is not exceeded. Furthermore, a line of credit does not shut down when the balance owing reaches zero.

Think of a line of credit as being similar to a credit card secured by your home, with the advantage of being at home loan interest rates rather than credit card interest rates (but unfortunately, there is no 55 day interest free option for a line of credit).

The primary advantage of a line of credit is that it provides a nexus which any and all investment property-related income (i.e. rental income) and property-related expenses (e.g. loan repayments, council rates, management fees, etc.) can be channelled through. This allows you to keep your property-related expenses (generally tax deductible) from your personal finances (which are not tax deductible).

Drawbacks associated with lines of credit are that they have higher interest rates than regular home loans or investment loans due to a combination of higher perceived risk and regulatory changes and are more difficult to obtain from lenders due to more stringent lending requirements being applied. They are also offered by a lower range of lenders for these reasons.

An interest-only investment home loan with an offset account works similarly to a line of credit. The offset account provides the nexus through which property-related income and expenses can be channelled and reduces your interest costs by using any remaining funds to offset the investment home loan.

A direct debit is set up between the offset account and the loan account. So long as the funds in the offset account are unused and the loan account is on interest-only repayments, the balances of these funds will remain equal and no interest will be charged. Interest would then be charged as the funds in the offset account are used towards an investment property purchase. This has the advantage of being less expensive than a line of credit, as interest rates for such loans are generally lower, and are more readily offered by a variety of lenders. However, the loan account will eventually revert to principal and interest repayments, meaning that borrowers will have to look at extending the interest only period or refinancing the loan facility prior to this occurring.

Whilst releasing equity from your home can seem complicated, it doesn’t have to be. A good mortgage broker can be invaluable in guiding you through this process.

If you’re interested in releasing equity from your home and would like to find out more about this process, simply give us a call on 1300 266 350 to speak to our finance team.