A line of credit is a type of loan extended by banks or private money lenders to borrow money for any purpose. It lets you use as much or as little as needed, and then you have to pay back whatever amount you owe with interest.
The personal line of credit is unsecured, which is why you will need a high credit score. You must also have a good history of repaying loans or debts in a timely manner, for you to avail personal line of credit.
Line of Credit vs Personal Loan
The biggest difference between a personal loan and line of credit is how the borrowed funds are paid out by the borrower.
In case of a personal loan, the amount to be borrowed is paid out at once in a large sum. You will get all the money upfront.
On the other hand, instead of borrowing all the money at once, the line of credit allows you to take out as much money as you need at a given time. It will have a credit limit and you can take out as much or as little money as needed, up to that limit.
How does Line of Credit Work?
When you apply for a personal line of credit, the lender will pre-approve you to borrow money up to a certain amount. The maximum amount will depend on your credit score and creditworthiness.
Once approved, you can take as much money as you need, up to the credit line’s maximum amount, at any given time. You can access the funds either through an electronic transfer, writing a check or via ATM card.
Once you take the money out, you will have to start repaying it immediately. The interest charged will only be on the amount withdrawn and not on the total borrowed amount. Your lender might set a minimum payment amount and the interest rates can go up or down depending on the prime rate.
The interest rate on this varies depending on a number of factors. Some include the type of lender, the amount you want to borrow, type, your credit score and the lending laws in your state. The personal loan interest rates are typically much higher than the interest rate for the personal line of credit.
Just like you would compare personal loan interest rates, compare the interest rates for line of credit as well. Regardless of how low the interest rate is, you must be able to afford the payments. So, ensure you borrow only as much as you can afford to pay back.
Uses of Line of Credit
Typical usage avenues are,
- Medical emergency
- Auto repairs
- Wedding expenses
- Address cash flow issues that may occur due to fluctuating income
- Emergency home improvements
- To clear off a bill that was higher than expected
Types of Personal Line of Credit
It typically falls into 2 main categories:
- Secured: This is backed by collateral such as real estate property, vehicles, or other valuable assets you may own. Secured line of credit comes with a very low interest rate because the collateral makes it less risky for the lender.
- Unsecured: Unsecured line of credit is not backed by any collateral. Its interest rate is usually very high since the lender will face a greater risk if you can’t pay back.
Three other types of credit lines available to applicants are:
- Personal: They come with different credit limits. You can choose repayment options and tenure. You may apply for a personal line of credit at the same institution where you have a checking account. You can use the money as you choose to. However, if your assets are held as collateral, they may be seized if you cannot pay off the balance in time.
- Business: You can use this type of loan to fund short-term finance needs like buying new equipment, purchasing inventory or paying other business expenses. You must present your registration papers, income tax returns and recent financial statements. You must also have a business certificate of deposit, good payment and credit history, and positive income.
- Home-Equity: Home-Equity Line of Credit, also known as HELOC, allows you to access funds for home improvement projects, emergency fixes and repairs. It is generally backed by your home’s value, which makes it secured. Due to this, HELOCs usually have very low interest rates as there is less risk to the lender. HELOC can be applied for with your mortgage lender or any other financial institute. It comes with a set timeline for when you can withdraw the money. This usually lasts 10 years before the line of credit will be called on for full payment.
Applying for a Line of Credit
The procedure to apply for one is quite simple. You can either go to your bank or use instant cash loan apps. In both cases, you need to submit all the required documents. Then the financial institution will check your credit score, monthly income and other factors before approving the loan request.
A line of credit can bail you out of financial emergencies – both personal and professional. Hence, keep your credit score high, be aware of the terms and apply only when you are in serious need of money.