Lines of Credit Versus Credit Cards.
When seeking funds, Line of credit is an option one can give consideration. I don’t know why line of credit seems unpopular as you hardly see people talking about it as such when compared to credit cards or other types of loans. One thing I have come to notice is that, financial institutions usually advertise products that give them high returns. This is reasonable of course. But as a consumer, that should send a message to you. If no financial institution is advertising lines of credit which is supposed to be a good source of finance to individuals and businesses alike, then something must be hidden. This may indicate that it is more beneficial to consumers than financial institutions. If you approach it this way, you may begin to reason that line of credit may be a good option for you to consider when seeking credit. What is line of credit and how does it work? That is what I will be addressing in the section below:
What is a Line of Credit?
A line of credit is a type of loan that your financial institution allows you to draw up to a particular approved limit. A line of credit is quite different from the traditional loan where a bulk amount is disbursed to you when the loan is approved. In the case of lines of credit, you don’t need to withdraw the whole credit approved for you at once. You can keep drawing on the credit based on your need per time. One good thing about lines of credit is that you don’t pay interest on the total approved credit. You only pay interest on the amount drawn from the credit. I think this is one of the reasons financial institutions don’t create much awareness of it.
Types of Lines of Credit
There are two types of lines of credit namely secured and unsecured line of credit. In the case of secured line of credit, you need to back up the credit with collateral such as house, vehicles and other valuable property. The essence of the collateral is that, if you default in the repayment of the loan, the lender can lay claim on the assets pledged as collateral. The interest on the secured line of credit is usually low because of the collateral which makes the loan less risky. The unsecured line of credit on the other hand does not require collateral. This usually attracts high rate of interest because of the risk involved. Also, it is more difficult to apply for unsecured line of credit. If you don’t have a very good credit history and good credit score, you should not even bother to apply for unsecured line of credit.
Advantages of Line of Credit
When you compare line of credit with credit cards and personal loans, you will clearly see where the advantages of line of credit lie. Below are the main advantages of line of credit.
The interest rates on lines of credit are considered low when you compared it to credit cards and personal loans. In most cases, the debt burden is not actually the problem with the repayment of the principal. It is the accumulation of interest that usually makes loans unbearable. When the interest rate on a loan is too high, it becomes difficult to servicing such loans. Before you know what is happening, the borrower may start making late payments and this may later degenerate to defaults in payments. The fact that the interest rates on lines of credit are reasonably low, the interest burden is not much on the borrowers. This makes it easy to pay at the end of each month. Interest on lines of credit is tax-deductible.
Lines of credit provide more flexibility for the borrower. You are not mandated to draw the entire approved credit at once. You only draw what you need per time. Also, you only pay interest on the amount you draw from the credit and not on the total credit amount. For instance, if you have a line of credit of say $25,000. You will not pay any interest on this amount until you start drawing from it. Even when you draw on it, the interest will only be calculated on the amount drawn only. If you draw $3,000, the interest will be on $3,000 and not $25,000. If it is a traditional loan, the interest is usually calculated on the total loan amount. Another way a line of credit provides flexibility is in the area of usage. You can use the proceeds from your line of credit for anything of interest to you. It can be used for home renovation, purchase of car, payment of medical bills and so on. Your financial institution is not concerned on how you apply the credit.
Higher Credit limits
If you compare lines of credit with credit cards, you will realise that you enjoy higher credit limit on a line of credit than what other loans or credit cards offer. Having a higher credit limit allows you to have access to more funds which you can use to make big purchase when required. However, you need to be disciplined on how you utilize your credit so that you don’t spend beyond what you can easily repay. Otherwise, you tend to lose your property or assets which you pledged as collateral.
Once your line of credit is approved, you have the credit readily available for use any time there is a need for it. You don’t need to start applying afresh each time you need funds. The only thing is that you cannot exceed the approved credit limit. If you want to increase your credit limit, you have the option of discussing with your financial institution to review the credit limit upward. On the other hand, you can apply for a new line of credit. But once approved, you have the money for your own use. Supposing you have an investment opportunity, you can easily and quickly make use of your lines of credit as you are free to withdraw the money at any time.
Disadvantages of Line of Credit
This article will not be complete without mentioning that lines of credit may have its own drawbacks. The disadvantages of a line of credit include the following:
Loss of Property
If you apply for secured line of credit which requires that you provide the financial institution with collateral, you can easily lose the property if you are unable to pay back the credit. Therefore, if you are not disciplined in your spending habits, you can easily run into debt. Easy accessibility to the credit can be very tempting. The antidote to this is to ensure you assess your financial capability to repay before you embark on any purchase using your lines of credit.
High Credit Score
If you don’t have a very high credit score, financial institutions will not be willing to grant you a line of credit. Before you can be considered for a line of credit, you need a good credit history and a very good or excellent credit score. So, you should understand that lines of credit are not available to all sundries.
A business line of credit is a fixed amount of money, which can be accessed as needed to meet fluctuations in cash flow.
Unlike a term loan, capital is available to withdraw as needed, instead of in a lump sum.
A line of credit offers flexibility because interest is only paid on credit when it’s accessed.
Secured and unsecured lines of credit are available from both banks and non-bank lenders.