What to Know About Lines of Credit

What to Know About Lines of Credit

A line of credit, also referred to as a loan, is an approved amount of funds that you can use now and repay later.

The terms of repayment may vary based upon the type of credit you acquire but typically involve regular payments towards your principle balance as well as interest charges.

The amount you can expect to pay in interest is determined by several factors, including your credit score and credit history. 

Lines of credit have several uses, including for a large purchase, to finance a home improvement project and to cover emergency medical expenses.

The amount of funds that a line of credit can provide also varies but may be anywhere from hundreds to thousands of dollars.

By learning more about credit, including how you may use credit, how to acquire a line of credit and the differences between secured and unsecured loans, you will be better prepared and have the knowledge necessary to make an informed decision on whether or not to apply for a line of credit. 

What to Use Lines of Credit For

Lines of credit are very similar to credit cards. However, credit cards always include unsecured loans, while a line of credit is far more likely to be secured and can generally provide far more funding than a credit card can.

Lines of credit can be used to pay for a variety of expenses, provide flexible access to funding and include interest rates until borrowed funds have been repaid.

However, this type of loan typically includes a more flexible repayment plan and commonly includes lower interest rates compared to those of traditional credit cards.

There are several reasons that you may consider acquiring a line of credit, including: 

  • For the purchase or construction of a home. 
  • To finance a home improvement project. 
  • To cover the cost of emergency medical expenses, should they arise. 
  • To finance a large purchase.

A line of credit may not be the ideal financing option for everyone.

Because most lines of credit are secured loans, these loans come with a considerable risk that could result in costly consequences if you fail to repay the amount that you borrow. 

Failing to repay a line of credit can result in serious consequences.

Not only can you expect severe damage to your credit score, but you can also lose any form of collateral that you used to secure the credit.

For example, if you put your home up as collateral, the lender can seize your home as collateral if you fail to repay your loan.

Therefore, a line of credit may not be your best option if you have irregular income or you are seeking a line of credit for smaller or monthly expenses.

The Difference Between Secured and Unsecured Lines of Credit

It is uncommon for a line of credit to be unsecured. Therefore, it is important to learn the difference between secured and unsecured debt in order to make an informed decision regarding your finances. 

A secure line of credit is a form of credit that requires some form of collateral.

Collateral can be a number of things of value, including a savings account, a home or a vehicle.

Should you ever fail to repay an amount that you borrow, the lender will have the legal right to seize whatever collateral you put up for the line of credit.

However, obtaining a secured line of credit over an unsecured one offers several benefits, including: 

  • Lower interest rates. 
  • Longer repayment periods. 
  • A larger amount of funds that can be borrowed. 

When determining whether or not to obtain a secured line of credit, it is worth weighing the potential benefits against the potential risks.

One popular choice of credit is a Home Equity Line of Credit (HELOC). This type of credit uses your home as collateral against the amount that you can borrow.

The value of your home will determine the maximum amount that you can borrow, as it is common for creditors to open a line of credit that has an amount up to 85 percent of the home’s value. 

Unsecured lines of credits do not involve collateral and are far more uncommon when it comes to lines of credit.

This is because lenders must take a greater risk when providing a line of credit that is not secured.

While you will not experience the level of risk that a secured line of credit may bring, you will likely experience a higher interest rate, shorter repayment period and a smaller loan amount. 

Learn How to Apply for a Line of Credit

If you would like to obtain a line of credit, it is important to prepare accordingly in order to obtain the type of line of credit that is right for you with the best possible loan terms.

The first step that you should take when considering a line of credit is to review your current credit score, income and debt-to-income ratio. 

Your credit score will have a huge impact on the type of loan terms you may be offered, specifically your interest rate.

The higher your credit score, the lower your interest rate will likely be. Additionally, having a higher credit score will impact whether or not you will be approved for a line of credit.

If your credit score is rather low, you may want to consider holding off on a line of credit, if possible, until you have been able to improve your score.

Doing so could potentially save you far more money in the long run. 

By examining your debt to income ratio and income, you will have a better idea of the type of repayment plan that you can afford as well as whether or not you can realistically pay any amount that you borrow off in the length of time that you are afforded.

Your debt-to-income and ratio will also impact whether or not you are approved for a line of credit as well as the amount that you may be approved for. 

Most lending institutions will allow you to apply for a line of credit online. However, some may require you to visit an office in person.

When submitting an application, you will need to provide your personal, employment and financial information.

You may also be required to provide proof of income, depending on your situation and the creditor. 

When searching for a line of credit, it is important to shop around and select the lender that will offer you the best interest rate and repayment options.

After submitting an application with the lender you choose to move forward with, you will likely receive an answer within a few days to a week of your application.

In some cases, you may be asked to visit a branch office to complete the closing process once you have been approved for a line of credit.