A line of credit, also known as a line of credit, is a pool of money that individuals, businesses, governments, and other organizations can borrow from. Credit lines offer the following unique advantages:
Convenience: After approval you can usually borrow whenever you need.
Borrowing What You Need: Although lines of credit have a maximum debt limit, you don’t have to borrow the entire amount allowed. Rather, you can borrow a small amount today and more later on a basis as needed.
Record Times and Maturities: A “draw” period is the amount of time you can borrow money from a line of credit that can take up to 20 years. The “repayment” period, in which you must repay all amounts you have borrowed during the draw period, begins immediately after the draw period ends.
Examples of lines of credit
There are different types of lines of credit.
Credit cards start with a zero balance. You then use the card to make purchases as needed. You can pay off the loan in full every month and start borrowing again in the same month. But be aware: Outdated balances usually result in hefty interest penalties.
Home equity lines of credit (HELOCs) let homeowners receive money from their home equity. Lenders typically limit the amount you borrow to 80 percent of your home’s value.
Business lines of credit provide working capital for small businesses. Since the tax requirements of companies are usually fluid, it is not practical to constantly apply for new traditional loans, so lines of credit make flexible loans easy and convenient.
Compare and contrast
Lines of credit are different from standard auto and home loans, where you borrow a lump sum of money up front after approval. But if you later find that you need additional funds, you have to apply for a brand new loan. This can be inconvenient and time consuming. Contrary, with lines of credit, borrowers do not have to re-apply for new loans every time they need money. So if you expect to borrow money multiple times throughout the year, a line of credit might be the easiest option. These loans help borrowers manage cash when costs are unpredictable and can even be placed on checking accounts to prevent overdraft interest.
How to spend: You usually get a check book or payment card that draws from your pool of available funds.
Manage Interest Costs: Since interest accumulates when you start borrowing, it is advisable to pay off your debts quickly.
Use wisely: lines of credit are best used as safety nets if you suddenly need cash immediately to cover an unexpected cost. But lines of credit are not ideal for routine use or for long-term loans. You can charge a fee every time you draw on your line of credit, and interest rates are usually higher than those with standard mortgage or auto loans.
How to get a line of credit
To get a line of credit, you have to apply as you would with another loan. Lenders will decide whether to approve your application and determine your credit limits based on the following award criteria:
- Your borrowing history. For most consumers, credit scores are examined.
- Your disposable income to repay the loan.
- Assets You can pledge as collateral.
Collateral is an asset used to secure the loan that your lender can take and sell if you fail to repay the loan in accordance with the agreed terms. Borrowers often put their homes as collateral for large home equity lines of credit with low interest rates. But a borrower, at risk of losing his or her home, foreclosure if payments are missed.
For entrepreneurs, it may be wise to put business assets as collateral such as commercial property, work vehicles, or equipment.
Money parked in savings and deposit certificates (CDs) can also be used as collateral to secure loans if you borrow from the same bank that holds your savings. This beneficial approach allows you to continue earning interest in these accounts while losing the risk of eliminating your home.
It is possible to get unsecured lines of credit where borrowers are given loans without posting collateral. But approval is more difficult, and interest rates are usually higher because the bank takes a higher risk.
Surprises from your lender
Unfortunately, banks may have the right to cancel your line of credit or lower your credit limit at any time. And they can also spike interest rates at will. For these two reasons, it is important to have emergency cash reserves available.