A line of credit is a tool that enables users to access funds and pay them back on their own terms.
It is a set amount of credit that a bank or a lending institution grants an approved applicant for personal use, and it can be anywhere from a few hundred dollars to several thousand dollars.
You may borrow as much against the line of credit as you wish during the “draw period,” which is the period of time during which you can take money from the line of credit.
When you draw money, you are charged a set interest rate on the funds until you pay them back. A line of credit is a valuable tool for people who have upcoming expenses and want flexible access to funding. Lines of credit function similarly to credit cards and provide you with a means to cover major expenses in your life.
They provide cash upfront and offer greater flexibility when it comes to repayment plans. Also, they are more likely to be secured than credit cards and typically have lower interest rates, as well as low to no annual fees that need to be paid.
People may seek a line of credit for a variety of reasons. Unlike a personal loan, which has a maximum set amount and is more suited to projects with fixed expenses and deadlines, the flexibility offered by lines of credit makes them ideal choices for someone who does not know how much a project will ultimately cost or how long it will continue.
Good uses for a line of credit include:
However, there are also times when a line of credit may not be the best choice for your financial situation. If you have an irregular income or are seeking a line of credit for smaller expenses, such as monthly bills or food costs, you may find yourself in trouble down the line when you enter the repayment period.
You should only use a line of credit if you know you will be able to pay it off in full when the time comes. Failing to repay your line of credit can severely damage your credit score.
If the credit line has collateral, such as your house or a savings account, the lending institution may seize the collateral in lieu of payment.
In addition, you should read the fine print for the terms of your line of credit carefully. Some institutions request a “balloon payment” at the end of the draw period, which is a return of the entire unpaid balance.
If your line of credit includes a balloon payment, you must make sure you have the assets available to pay the entire cost back immediately at the end of the drawing period.
There are two types of lines of credit: secured and unsecured. To obtain a secure line of credit, you must put down some form of collateral. This can be anything from a savings account to a certificate of deposit, but it can also include the value of your home.
A HELOC is a home equity line of credit, which uses the value of your home as collateral against the line of credit. A bank or lending institution will typically let you open a line of credit worth up to 85 percent of your home’s value.
However, there is significant risk in opening a HELOC if you are unable to repay the credit. A bank may seize your home if you fail to keep up with the interest or repay on time.
The upside of using a secured line of credit is that it typically comes with lower interest rates, which means you will not have to pay back as much as you would with an unsecured line. In addition, it has a longer drawing period of 10 to 20 years.
Unsecured lines of credit do not involve collateral. However, lending institutions take a greater risk when they issue an unsecured line of credit. As a result, interest rates will be higher, and the total line of credit may be smaller than the lending institution would issue for a secured line of credit.
The drawing period is also typically shorter, lasting three to five years rather than 10 to 20 years.
If you are interested in obtaining a personal line of credit, you should begin by checking your credit score. A low credit score can hurt your chances of being approved for a line of credit or cause a lending institution to approve your line with a higher interest rate.
If you have a low credit score, consider taking steps to improve it with regular financial activity and debt repayment before applying for a line of credit. If your credit score is good or excellent, you can apply for a line of credit without concern. In any case, lending institutions will also consider your debt-to-income ratio and borrowing history when deciding how much credit to grant you.
Most lending institutions allow you to apply for a line of credit online. You will need to provide information regarding your contact details, employment, level of income, desired line of credit and how long you would like the line of credit open.
Before you select a lending institution, make sure you shop around for the best annual percentage rate (APR). An excellent line of credit will have an APR below 4.5 percent. However, some institutions offer lines of credit with interest rates above 10 percent.
Once you fill out and complete an application through your chosen lender, you should receive an answer fairly soon afterward. If you are approved, you may be asked to come in to an office to complete the closing process in person in order to open the line of credit and begin drawing money.