What exactly is a line of credit? A line of credit allows you to have cash on demand for large expenses like repairs or home improvement projects. Sometimes, you can have a relatively high amount for a set time period.
When you use your line of credit, you will pay interest for the use of these funds. However, this amount is available for you to use again after paying the funds back. As long as you follow the terms associated with the credit line, you can make use of it as often as necessary.
We’ll take a closer look at what credit lines are and how you can tell if this is the right option for your circumstances.
What Exactly is a Line of Credit and How Does It Work?
Lines of credit differ from loans because you only pay interest when you borrow the funds. Loans, on the other hand, require monthly payments after you receive your funds.
Many personal lines of credit are unsecured, so you don’t have to offer your home or car as collateral. The better your credit score, the lower your interest rate. Depending on the lender, you may have borrowing limits or an annual fee.
Lines of credit have “draw periods,” which are amounts in time during which you’re permitted to draw money. These funds are transferred to your bank account or onto a payment card.
Minimum payments are required once you start using your funds, but, as you make the payments, these amounts become available for you to borrow again. The repayment period in which you must pay back the remaining balance starts after the end of the draw period. Although making only the minimum payment amount is tempting, this will cost you more in interest charges over time.
Does a Credit Line Affect my Credit Score?
Part of the discussion about what exactly is a line of credit should include possible effects on your credit score. Because lenders must do a “hard” inquiry, this will lower your credit score temporarily.
New lines of credit appear on your credit report as new accounts. The actions that you take will impact how the credit bureaus report your activity.
Using only part of the line of credit or never having to use it will result in a lower credit utilization rate, which indicates how much of your available credit you’re using. Borrowing higher amounts of credit increase your credit utilization rate and could hurt your credit score.
Also, you need to make sure that your payments are on time. Otherwise, this may also affect your overall credit rating.
What Exactly is a Line of Credit and How Is It Different from Credit Cards?
Although lines of credit are similar in many ways to credit cards, there are also key differences. Unlike lines of credit, credit cards lack a draw period, instead of allowing you to use credit if your account is open in good standing.
Another difference is that credit cards often offer cashback rewards that you can put towards paying off your balance. These programs make credit cards more suitable for daily spending than credit lines.
Credit cards have higher interest rates than most lines of credit. There are also substantially lower borrowing limits with higher fees if you take out an advance.
How Do You Use it?
Taking steps to boost your credit score before applying increases your chances of getting a good rate. You’ll have a better idea of how to best spend your money and the amount you’ll get with careful planning.
Flexibility is key for those who benefit the most from a line of credit. However, there are some borrowers who aren’t good candidates for lines of credit. Let’s look at these circumstances next.
When Should I Avoid Using it?
People with unreliable incomes or those who are unsure of their ability to make payments may not be good candidates for credit lines. If you’re sure of the exact amount that you need, loans might be a better choice. You’ll likely also want to veer away from credit lines for everyday spending.
When Should I Use a Line of Credit?
Anyone who has major expenses like educational costs or home improvement needs and is sure of their ability to repay the funds is an ideal candidate. Also, if you’re paying off multiple smaller debts, a credit line might be a better solution.
If the answer to what exactly is a line of credit is satisfactory and you want to pursue this option, contact us to find out how to get started.