What is a line of credit?
A line of credit is a revolving amount of credit that allows you continual access to funds up to a set limit. Unlike with a personal loan, you can withdraw funds as you need them, instead of having to receive your approved funds as a lump sum.
Once your line of credit’s limit has been set, you can draw as much as you like and pay it back over time. As you pay back what you’ve borrowed, you regain access to those funds for future borrowing.
Unlike some loans, lines of credit do not need to be used for a specific purpose and can usually be paid back on a less-defined timeline. You may be able to access the funds at a lower interest rate than you’d get on a credit card, as well.
How much does it cost?
As with any type of credit, you’re likely to get a lower interest rate, when you have a higher credit score. That being said, a line of credit should usually have a lower interest rate than most loans and credit cards.
If you don’t use any of the line of credit, there won’t be a charge, but you will be charged from the day you take money out, until the day it’s paid back in full.
There could also be fees associated with a line of credit – such as set up, or annual fees, so it’s important to check with the lender and factor these into your costs.
So why now?
There’s a famous saying that says ‘the oak breaks in the storm, but the willow bends’. This is just a poetic way of saying that in turbulent times – like those we’re seeing now – being flexible may end up helping you stay afloat.
The flexibility of a line of credit is very similar to a credit card: if you don’t use it, you aren’t charged (in most cases). However, when you do use it, a credit card tends to be much more expensive than a line of credit.
Secured vs. unsecured lines of credit
A line of credit can either be secured by collateral or be unsecured. This has a big effect on what lenders offer.
Secured
With a secured line of credit, an asset that’s used as collateral “secures” the money you borrow from the lender. That asset serves as security if you fail to repay the line of credit according to the loan terms.
A home or car is often used as collateral in these cases, but any item with a value high enough to secure the funds may work. In this scenario, the risk should be clear — if you don’t pay back the money you owe, then the lender can move to take the asset. The main benefit of a secured line of credit is that you’ll typically get a lower interest rate than you’d otherwise be offered on an unsecured line of credit.
A home equity line of credit, or HELOC, is a common secured line of credit. In this situation, the borrower’s home is the collateral. Because homes tend to be especially valuable assets, HELOCs often have a higher limit and lower interest rate than other lines of credit. Keep in mind that borrowing against your home is risky, so be sure you can afford the repayments.
Unsecured
With an unsecured line of credit, no assets are put up as collateral, so the interest rate depends largely on information in the borrower’s credit profile.
When setting the limit on your unsecured line of credit, your lender will consider several factors, like your income, any existing debt and your credit reports. Lenders usually require a minimum household income to approve a line of credit.
Many personal lines of credit and student lines of credit are unsecured. A personal line of credit may be ideal if you need money to consolidate debt. Meanwhile, a student line of credit is money you can borrow for attending college or university. It can be used to help cover related expenses, like books, tuition and student rent.
Bottom line
If you’re looking to borrow at the moment, a line of credit could be a flexible option that provides a safety net for you in difficult times. As with all types of credit, the decision to apply should be carefully considered and it’s always important to check the details of any credit agreement before you take it out.