September 11th, 2017
What do you do when clients come to you in need of funds for specific requirements such as medical expenses, their child’s education costs, or even home renovations? If they have plenty of equity in their home, a Line of Credit (LOC) facility may be an option.
What is an LOC?
A line of credit (or LOC) loan, also known as a home equity loan, allows your clients to withdraw the funds they need as and when they need it. Put quite simply, an LOC means your client has an approved credit facility and they can borrow as much or as little of this amount as needed with the interest paid only on the balance.
When is an LOC a suitable option?
To determine if a LOC is appropriate for your client, you need to understand what the funds will be used for and the needs and objectives of your client. To ensure that an LOC facility meets your client’s needs and objectives, you need to be covering off the below pros and cons of LOC during your discovery conversation.
What are the ‘pros’?
Lower interest rate: A big advantage for a LOC facility is that as it is secured against your client’s property, your client presents a lower risk to the bank than, say with a personal loan or a credit card. This may mean a lower interest rate is payable. So if your client wanted to use the equity in their home to purchase a new car, for example, they are effectively borrowing for a car at home loan interest rates.
Flexibility: Your client will have greater flexibility in managing the size of their limit which enables them to make repayments at any time and enables access to additional funds without the need for further approval. As your client can keep their entire income in their account until its needed, a portion of their income stays in the loan account longer, and can save your client interest.
Longevity: The LOC does not have a specific loan term. This means they can use the LOC facility for as long as they need it. However, you will need to explain to your client that the facility will need to be paid back at some point – a clear exit strategy will need to be discussed which could be full repayment prior to retirement, or ongoing servicing after retirement.
What are the ‘cons’?
LOC facilities sometimes have some not-so-appealing features your clients should be made aware of. These features should be discussed with your client so they fully understand the effect they may have on their financial position.
Money management: Remember that with an LOC facility, your client will put their home up as security. If they mismanage their loan, they could stand to reduce the equity in their home, or even find themselves in a position where they have to sell to meet their financial obligations.
Fees and charges: Monthly or annual fees are usually attached to these products, most come at a price, and the extra funds your client needs to shell out for a loan feature may not actually pay off financially than another kind of loan product.
It may take longer to pay off their home loan: By using the equity in their home as an LOC facility, they may take a longer period of time to repay their original home loan. This may cause your client to pay more interest in the long-run, and take more time for your clients to own their own home debt free.
Overspending: Your client only pays interest on the remaining balance calculated daily and charged monthly on an LOC facility. However having funds readily on hand can be tempting! It may potentially result in your client drawing out more than they would otherwise spend, or dipping in more often and not paying the balance back down as intended. This could lead to extra debt through overspending.
Evidence is key!
Whatever the reasons for providing your client with an LOC loan may be, the purpose and the amount of the LOC facility needs to meet your clients’ needs and objectives.
To meet your responsible lending obligations under NCCP, please ensure you are documenting the conversations you have with your client. If someone were to ask you to evidence what discussion you had with your client in regards to a line of credit facility, what would you need to provide? The same as with any other type of loan! Detailed notes of your conversations, email templates and correspondence all can evidence that you are meeting your responsible lending obligations.
Contact the Compliance Team with any questions
If you have any questions about Line of Credit facilities, the Compliance Team will be happy to help. Get in touch by clicking your help icon in Mercury or simply email us directly at email@example.com