What Is a Line of Credit

Fluctuating fortunes mean there will always be times when assistance is required to plug financial gaps, pay bills and keep the business afloat. There are options for quick finance, such as credit cards, but interest repayments can make them cost-prohibitive in many situations. An alternative loan option is a line of credit, with lower interest rates and other budget-friendly features.

A bank line of credit provides customers the opportunity to borrow additional funds or utilise equity. Banks extend lines of credit (LOC) for a multitude of purposes, from home renovations to business expansion and more. The most well-known of this loan type is the home equity line of credit (HELOC), usually used for renovating or remodelling established residences. A line of credit is also accessible to the self-employed, those with inconsistent earnings, and people wanting to get their business off the ground.

How is a line of credit different to other loans?

Bank loans are tailored for a wide variety of purposes. Each loan type has characteristics that are matched with customer requirements, and a line of credit is no exception. With a line of credit, the customer only pays interest on money used, in contrast to traditional loans that incur fixed interest repayments for the full loan term. In other words, if a line of credit is $10,000, and no money is withdrawn, there are zero repayments.

A line of credit is in many ways like a credit card. The major difference for most people is the greater credit limit and lower interest rates associated with a line of credit. This makes a line of credit much more versatile and practical, enabling customers to continually reuse and replenish a greater pool of money. Smart spending with a line of credit can help restore a neglected home, stimulate business growth, or even kick-start a whole new career. A line of credit provides the freedom to hold on to funds and use them when the time is right.

What else can a line of credit be used for?

A line of credit is particularly useful for people with equity and those with established financial acumen. It’s common for older home owners to use a line of credit for renovating a tired old residence, while younger borrowers use the credit to make steady steps up the housing ladder. Depending on financials, a line of credit can be used for almost anything, including vacations, higher education, cars, boats and other essentials – as long as repayments are made on time. There are two basic types of lines of credit; secured and unsecured.

• Secured: A secured line of credit is tied to collateral. This could be any asset owned by the borrower, such as a home or vehicle. Secured lines of credit carry less risk for the bank and low interest rates are therefore expected.
• Unsecured: As there is no collateral backing an unsecured line of credit, eligibility is determined by individual financial status and history. Greater risk to the bank results in higher interest rates.

Establishing and using a line of credit is quite straight-forward. If the line of credit is established with your usual bank or lender, your bank accounts can be linked for direct transfer of funds whenever required.

How long does a line of credit last?

Lines of credit are used to facilitate both short and long-term plans. A home equity line of credit, for example, can last for many years and be repurposed for additional home repairs, renovations or improvements. A business line of credit provides a boost to fund short-term needs during transition or expansion. A line of credit can also cover operating expenses and wages during a short-term lull in productivity. When managed astutely, a line of credit will provide financial advantages and remain available whenever required.

Applying for a line of credit

It’s well worth investigating the line of credit deals available from different banks and lenders. Banking is an extremely competitive industry, and if your financials are sound, banks will compete for your business with better rates and lower fees. There are a few questions that need to be asked:

• Are the interest rates fixed or variable?
• What other fees are attached to the loan?
• What are the payment plans and schedules?
• Can your bank make a better offer?

A line of credit has many uses, and can be a smart financial tool when used wisely. It can assist with financial stability and be on hand for investment when an opportunity arises. As with all loans, there are inherent risks that are fully negated with sound money management.

Read the original article on Aussie Finance Blog