When is a line of credit not a true line of credit (LOC) ? – by Jenna Ford
One of the all time favourite loan products with investors in recent years has been the lines of credit. It’s been often used for it’s product flexibility and ease in allowing borrowers to come and go from the facility with the ease of a large credit card and without the need for the borrower to go back to the lender and ask permission to draw on unused funds or park surplus monies in this loan account until they are required.
Recent changes in the regulations (The National Credit Consumer Protection legislation – NCCP) governing lenders and brokers have somewhat curtailed the flexibility of the Line of Credit product features offered by most lenders and so it’s well worth while being aware that there can be significant differences between what’s on offer from various lenders in the Line of Credit arena. There are definitely standout winners and some dogs to be avoided.
The features you might remember from the old LOC products may have been discontinued in the last 2 years of grueling credit policy changes. Originally, a “true Line of Credit” operated like a giant credit card with a set limit and the ability to come and go from the loan account without recourse to the lender.
Now its best to really check out what you are getting when you choose a LOC loan product. Here are a few key features to check, a brief explanation of why some lenders have restrictions on these features and a tip on which lender may still offer this feature:
Credit Limit for the term of the loan: The true old fashioned “evergreen” Line of Credit is a product where the credit limit remains the same for the life of the loan – 25 or 30 years – without the requirement to pay it down with reductions in principle. Under NCCP this true Line of Credit is almost extinct because it is deemed by the legislators to be impossible to prove at the start of the loan that a borrower can afford to pay the full loan amount in one go at the end of the term of the loan. Most Lines of Credit now run an interest only term for 5 or 10 years followed by required Principle and interest payments for the remainder of the term. Exceptions to this are and CBA’s Line of Credit and Westpac’s Equity Action loan.
Capitalising of loan payments – the true LOC allows the borrower to forgo making a regular monthly payments to the lender if there are sufficient funds unused within the loan account to cover this monthly payment. Many investors have used this feature of the Line of Credit to divert cash flow away from their monthly loan payments in the short term and into acquisition of more assets. The requirements under NCCP are heading towards a requirement on all lenders to ensure that borrowers do meet a regular payment of interest on all loan facilities rather than allowing a capitalising of interest and an increasing debt level over time. Residential investors used to taking advantage of interest capitalization will need to adjust their investment strategies in light of these incoming requirements. Within the area of commercial construction and development the feature of interest capitalization will continue as commercial lending is not as touched yet by NCCP regulations. An exception to the non allowance of capitalization of interest payments is again, Westpac although we do not know for how long this feature will last. AMP and CBA have some tolerance of this payment pattern as well although on the loan contract there is a requirement that the borrower makes a monthly interest payment.
“Cash out” restrictions. Old style Lines of Credit enabled a borrower to settle a loan with a credit limit at the level that they were approved at, but to leave the funds undrawn for use at a later date at their own discretion. Currently many lenders restrict the amount of money that can be given in a loan where a clear and specific purpose is not immediately demonstratable to the lender. Funds without a specific and demonstratable purpose are termed “cash out”. In a distinctly patriarchal way lenders now can refuse cash out or severely limit it. If you want the funds for an unspecified future investment purpose you may well find that you are refused the money or have limits set on the amount, so do check this out before you choose the lender you are going to apply for a loan with. Occasionally, where a lender is refusing “cash out” on one of their products standard variable products, there can be a window of opportunity with the same lender by using their Line of Credit product. A good example here is the Macquarie Mortgages’ Line of Credit, AMP’s Line of Credit (full docs) with no restriction on “cash out” up to $2 million and 85% Loan to Value Ratio and again Westpac’s Equity Access Loan.
A premium product attracting a higher interest rate because of its additional features? Generally Lines of Credit have an additional interest rate loading. Lenders claim that the product requires more administration and this cost needs to be covered – hence the higher interest rate. Westpac and CBA load the rate by 0.1% and AMP loads the rate by 0.2%. An exception to this Macquarie Mortgages’ Line of Credit account offered at the same rate as their standard variable loan.
One excellent strategy for minimizing interest rate whilst retaining flexibility of usage is to use an Offset Account linked to a Standard Variable or Basic loan. The Offset account provides the transaction flexibility of a bank account whilst the loan itself can be fully drawn and monies not immediately required are placed in the Offset Account where they reduce the interest payments of the loan. AMP has an excellent Basic Loan with full 100% offset that suits this strategy well.
Recent broker reviews of Lines of Credit rated 9 of currently available Lines of Credit products on product features, interest rates, fees (upfront, ongoing and exit fees) credit policy, ease of dealing with the lender and service delivery timeframes. Whilst each lender featured well on at least one of the parameters measured in study, the overall best performer was Macquarie Mortgages’ Line of Credit who reentered the residential lending market again only one year ago. (The Adviser – February 2011). The overall ranking for Lines of Credit in 2011, starting with highest scorer, is as follows:
- Macquarie Mortgages Mix and Match
- Westpac Equity Access Loan
- CBA Line of Credit
- Advantedge Pro Pack
- St George Portfolio
- ANZ Equity Manager
- ING Direct – Equity Action Loan
- Suncorp – Asset Line
- AMP Pro Pack Line of Credit.
Note, however, that there may be other factors influencing your cleverest choice of whose Line of Credit will suit you. A couple of notable factors we run into frequently when working with clients at Chan & Naylor Finance are:
- The choice of a lender needs to accept security properties held in Hybrid Trusts and some of the above lenders do not
- The ease/difficulty of each lenders serviceability calculators where capacity to borrow is tight. There can be large differences in how lenders assess your capacity to service a loan and if servicing is tight then choice of a lender with an easier serviceability calculator may be wise.
If you are considering which Line of Credit product or lender may suit your needs feel free
to give us a call 02 9391 5053 or email us to discuss what are the most recent lender offerings.