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What is a Line of Credit?

A line of credit is a credit facility extended to an individual by a bank or credit union. It enables the customer to access cash whenever the customer is in need of money. You will have to pay interest on the amount you owe.

A line of credit takes several forms such as an overdraft limit, demand loan, special purpose, export packing credit, term loan, discounting, purchase of commercial bills, traditional revolving credit card account, etc. Line of credit is considered an effective source of funds that can readily be tapped at the borrower's discretion. A line of credit is either secured or unsecured. Under this form of credit, the interest is only being paid on the amount actually borrowed.

The plus points:

  • A line of credit has built-in flexibility
  • A line of credit is an open-end credit account, which allows borrowers to spend the money, repay it, and spend it again in a never-ending cycle.

The minus points:

  • Potential downsides of line of credit include high-interest rates
  • Severe penalties for late payments
  • Having the potential to overspend

A line of credit is a rotating financing option that allows you to access money when you need it. The borrowed amount is repaid in minimum regular payments or in full, whatever the borrower is comfortable with. Interest fees will be imposed on the sum of money borrowed by the customer and if the account is not used, then there will be no charges. That is why they are different from overdraft accounts.

A line of credit serves a number of purposes:

  • It is attached to the equity in your house and can be used for maintaining and renovating the house.
  • It is attached to your checking account that protects your account from overdrafts.
  • This account provides the customer complete satisfaction that additional income is available at any time when any sort of emergency pops up.
  • It can cover checks when the balance in your account is not sufficient enough.
  • It can be used to pay bills on time and also to control the astonishing costs.

For having a line of credit you are required to complete an easy and short loan application. The representative from a company that offers such facility will perform a credit check to guarantee that your credit is in good standing. This process may take one or two days to two weeks. You will be provided a limit like a credit card once your credit line is approved. Upon approval you are allowed to use the credit line whenever you want extra cash. The customer needs to pay back the borrowed principle amount and the interest charged in minimum monthly installments or in full.

A line of credit is available in a variety of different ways. You may be able to qualify for a line of credit loan, depending on your financial situation and credit history. Each form of line of credit is different from the others and all provide you with the benefits of accessing cash that can prove helpful in a time of need.

However, it is better if you seek financial advice from your banker or reputable financial adviser before you makes a decision. As there are several types of line of credit loans available this means that you need to know about each kind of loan in detail, so when you make a selection you can pick the best one that works for you.

Whether you are planning a home renovation work or some unexpected car repair expense, a line of credit could be a most effective means to tackle those expenses. Thanks to line of credit you can able to access to funds on demand. It is offered by banks or credit unions, and if you qualify, you can draw money up to the maximum allotted limit for a set period of time.

Flexibility is the most advantageous thing that you get with a line of credit. You can choose when to take the money, pay it back and can repeat the process as many times as you want as long as you stick to paying off the borrowed amount and the interest charged on time. You will pay only interest when you borrow money with a line of credit. Once you pay back the borrowed funds, the amount is again available for you to borrow.

When you apply for a loan, you get a lump sum of money and start paying the interest immediately regardless of when you use the money. But in line of credit, you can withdraw the set amount of funds that you can borrow when you need it but you don’t need to pay any interest until you actually borrow the amount.

Personal lines of credit are usually unsecured in nature and don’t require any collateral. However, secured lines of credit are backed with collateral that you can be your home, savings account or any other valuable asset. Having a good credit score can help you qualify for a lower annual percentage rate. Some lines of credit come up with annual fee and limits on the amount you can borrow.

After successfully qualifying for a line of credit, you will be given a ‘draw period’ that can last for several years. The bank may offer you special checks, a card to use or transfer the amount directly to your checking account, when you need to withdraw the money. The moment you withdraw the funds, interest usually starts to build up and then you have to start making minimum monthly payments. However, once your draw period ends, you will enter the repayment period. Now you will be provided a set time to pay off any remaining balance. Just keep in mind that making only minimum payments may cost you more in interest in the long run.

Before you take out a line of credit, secured or unsecured, just make sure to check your credit scores. The higher the credit score, the higher are the chances for a best rate. Take steps to boost your credit, so that you can improve the chances of getting a better rate. After that you need to figure out how much money you need and how you plan to spend the money.

When and when not to use the line of credit:

When-

It is a flexible way to borrow when you need the money for home renovations, education, paying off high interest debts or other types of major expenses, a secured line of credit may be a good idea as long as you have the money for repayment.

Thanks to unsecured personal line of credit you may able to consolidate several small debts you are paying off into one payment with a lower APR. Here you can avoid risking your asset as they are unsecured in nature.

When not-

Getting a line of credit is not a wise idea when your income is not unstable and you are not sure about if you can afford to make payments.

If you have plans to use a line of credit for short term expenses like going out on vacations, paying entertainment or dining out expenses, then that could put a red flag on your profile which signifies that you are struggling financially.

Know which one is better-loan or line of credit

It has been observed that loans are better for large, one-time investments or purchases. This could be buying a new home, car or paying for an education expenses. Lines of credit, on the other hand, are better for ongoing, small or unplanned expenses.

Loans usually have fixed interest rates and it will not change during the life of the loan. On the other hand, many lines of credit have variable rates as the prime rates changes, so will be interest rates on the line of credit.

Conclusion

If you are interested in a line of credit, speak to your banker. Acquiring any type of credit line depends on various factors such as your income, your credit history and your relationship with your bank. Generally, you will have no payments due on the line of credit loan until you start using it. It can be used for several different ways and to meet any important financial purposes ranging from consolidating debts, paying off credit card bills, buying a car, home renovation work and more. In this case, you have the facility to decide when you want to access the funds, how to use them and when to pay them. You can start paying off with minimum monthly payments within set period of time or can pay in full. There is secured and unsecured line of credit available to choose from. Compare the features, fees, interest and other important aspects of loans and lines of credit before you make a choice. A careful comparison can help in selecting the right option for you with a better rate.