Understanding Lines of Credit

When it comes to choosing what line of credit to take out, there are a few things to understand first. In this article, we’ll discuss everything you must know, from how they work to how to get one.

A line of credit by definition is a type of loan that allows borrowers to access a set amount of funds, which they can then use as needed. The flexibility of these loans makes them an attractive offer for many borrowers. But before you make any decision you must understand how they work and what their potential risks and benefits are.  

The flexible terms allow you to just go ahead and borrow the amount you need and pay it back when you are able to do so. And with low-interest rates, these loans are an option of choice for people who need funds for larger purchases or other unexpected expenses.  

However, like any other loan type, they do have some drawbacks, so be cautious. They are a revolving line of credit, so a borrower can feel tempted to spend more money than they can later pay back. These actions often lead to significant debt and financial problems down the road.  

If you’re considering taking out a line of credit loan, it’s important to first do your research and completely understand how they work.   

What Exactly Are Lines of Credit or Credit Lines?

These loans are a type that allows borrowers to tap into a set amount of funds as needed. Borrowers are only responsible for paying interest on the portion of the loan they took out and used and are able to access the funds at any time. Lines of credit are a popular choice for businesses in order to manage cash flow or unexpected expenses. Many lenders even specialize in the small business line of credit loans but don’t forget that these loans can also be used by individuals for major purchases like home renovations for example.  

There are two main types of lines of credit: secured and unsecured. A secured line of credit needs to be backed up by collateral, typically in the form of a savings account, piece of property, or some other asset. An unsecured line of credit doesn’t require collateral, but as a result of that, usually has stricter eligibility requirements and comes with a higher interest rate.  

Now that we cover what is a line of credit it is also important we mention that if used wisely, they can be a helpful financial tool. Still, offering quick access to cash has many potential risks involved so once again be sure to do your research.  

How Do Lines of Credit Work?

They are one of the most popular and versatile types of financing available. The funds gained this way can be used for a variety of purposes, from funding a home improvement project to consolidating debt. But how do lines of credit work?  

Well, first of all, they give you an opportunity to borrow up to a certain limit and then repay the loan over time. As you make these payments, your available credit line begins to replenish, giving you the ability to borrow again if needed. This is essentially their biggest upside- flexibility. You can draw money when you need it, and because this fund keeps replenishing, you don’t have to apply for a new loan if you need more. That being said, it’s important to remember that a line of credit is still a loan, and should be used responsibly.  

If you’re considering taking out this loan, be sure to shop around and compare offers from different lenders as they can vary quite a bit. They typically have lower interest rates than other types of loans, but it’s still important to take your time and find the best rate possible.  

Once you get approved for a line of credit, be sure to monitor your balance and make payments on time. If you miss them your credit score will take a toll.  

Common Types of Lines of Credit

There are several types of lines of credit available for either individuals or businesses so you can just take a pick which one suits you best. All of them come with their own set of benefits and drawbacks so take this into consideration as well. Some of the most common types of lines of credit are:  

Personal Lines of Credit  

They allow you to borrow money up to a certain limit. You still have the flexibility to use the money for whatever you want. They also come as a secured or unsecured type to choose from. People use them as a popular alternative to credit cards as they typically offer a lower interest rate. The whole application process here is typically much easier than applying for a more traditional loan. And, once you’re approved, you can access the money right away. If you for example dream of a new car, but just don’t like deals on auto loans, PLOC loans can be a great alternative to look into.   

Nonetheless, there are a few things to watch out for. First, make sure you only borrow what you need. It’s easy to get into the habit of using your line of credit for everyday expenses, but this can quickly get out of hand.  

Home Equity Lines of Credit  

If you’ve been thinking about taking out a home equity line of credit (HELOC), the chances are you are probably not alone. In the past years, these loans have become increasingly popular among borrowers who have equity in their homes.  

How this works is if you for example have a home that is worth $250,000 and you have a mortgage balance of $50,000. That means you have $200,000 in equity. By choosing this loan, you can borrow up to that limit.  

Business Lines of Credit  

Business owners, who may be looking for a way to grow their business or finance another venture often consider this loan type. Here you as well only pay interest on the money you borrow, and can typically renew the line of credit when it expires, so owners prefer it as opposed to applying for a new loan every time they need money. A business line of credit can be a flexible and affordable financing option even for small businesses.   

Secured vs. Unsecured Lines of Credit: What’s the Difference?

If you’re currently in the market for a line of credit, you may be wondering whether to choose a secured or unsecured option.  

As we already discussed, a secured line of credit is backed by collateral, which can be an asset such as your home or car. This means that if you default on the loan, your lender can go ahead and repossess the collateral to recoup their losses. Because of this, secured lines of credit usually offer lower interest rates than unsecured ones.   

An unsecured line of credit is not backed by collateral. This means that if you default on the loan, the lender cannot take your assets. However, this makes it riskier for the lenders so they usually charge a higher interest rate.   

So, which is the right fit for you? Ultimately, it depends on your personal and financial situation.

Pros and Cons of Lines of Credit

Lines of credit can be a great financial tool, but like any other type of borrowing out there, there are some benefits and drawbacks to it.  

Pros:  

• You can access the funds when you need them. There is no application for a new loan if some larger expense arises. 

• They come with lower interest rates. This can save you a bit of money in the long run as opposed to choosing some other loan types.  

• It will build your credit. Using a line of credit responsibly can help improve your credit score over time which will give you even more opportunities in the future.  

• Can be a great safety net to have in case of an unexpected financial emergency.  

• Flexible repayment terms, so you can fit your payments just how you want in your budget.  

Cons:  

• Can be difficult to qualify for. Lines of credit typically require good or excellent credit in order to qualify.  

• They can come with variable interest rates, which means that the payments can go up or down over time.   

• If you miss a payment or default on your loan, this can seriously lower your credit score, making it more difficult to borrow any money in the future.  

How to Qualify for a Line of Credit

If you’re considering applying for a line of credit, you may be wondering how to qualify. Here are some things you need to know.  

Most lenders will require that you have a great credit score and a steady source of income before they will seriously consider your application. They want to be sure that you are able to repay the loan, especially if you haven’t put down collateral. You’ll also need to have a good history of borrowing money. If you’ve had problems with debt in the past, it may be difficult to qualify for a line of credit. Lenders will want to see that you’ve been responsible for previous borrowings.

Bottom Line

These loans can offer you great flexibility if that is something you are looking for, but they might not always be a good fit for you. While we cannot tell you what to do, we gave you a good understanding of what they are and what they involve. It would still be a good idea to talk to your financial advisor in order for you to get a good comparison of the interest rates and terms before you apply.