Line of Credit Guide: What Exactly Is It?

Line of Credit Guide: What Exactly Is It?

When searching for a loan, you probably come across options like secured and unsecured personal or commercial loans. But these two are not the only types of loans to choose from. One more option that you have is a line of credit. Most people apply for a loan because they need funds for emergencies. If you want easy access to cash in case of an unforeseen event, a line of credit may work for you.

What is a Line of Credit?

A line of credit is a type of loan that shares similar traits with a credit card. It can either be a personal loan or a business (commercial) loan. A line of credit differs significantly from other types of loan. Instead of borrowing funds from a lender in which you get the agreed amount upon dispersal, you will have a revolving line of credit.

Line of Credit vs Other Types of Loan

Most types of loans are in the form of an instalment where you have to pay usually a fixed amount over a certain period. If you apply for a secured personal loan, you will receive the amount that the lender has agreed to give you. Then, you are required to pay off the loan over a particular number of months. The payment will also include the interest and other fees if there are any.

It is easy to see the distinction because a line of credit replenishes over time, typically every month. There is an agreed-upon threshold, which is called the credit limit. If your credit limit is $5,000, you can use the available funds anytime you wish. However, you are obligated to pay at least the minimum required amount in order for the line of credit to replenish. 

Meanwhile, a standard personal loan presents you with the whole amount you borrowed, which is then moved to your account. It’s a huge distinction from a line of credit because you’re granted access to a certain amount. The money remains and does not expire or reduce until you decide to use the funds for a specific purpose.

The concept is the same as a business line of credit. Basically, you are given a specific credit limit that you can use for business purchases or expenses. You will not receive an upfront lump-sum payment, unlike with other types of business loans.

How Does a Line of Credit Work?

As mentioned, a line of credit combines the characteristics of a credit card and a personal loan. Let’s see why:

  • You can draw on funds conveniently.
  • You pay towards your balance, plus the accrued interest.
  • The payments are made through monthly instalments.
  • Upon repaying the amount you used (and the interest), your line of credit refills itself to a predetermined limit.
  • You can continue using the credit whenever you need to.

Even with some similarities with a personal loan, you only pay the amount you borrowed during that specific time. The interest you need to pay is usually based on the money you use, making it incredibly cheaper. A personal loan’s interest is based on the entire amount you have been approved to borrow.

You are probably familiar with how a credit card works. If so, it is easier to understand how a line of credit functions. You gain access to a credit limit, which you can utilise at your discretion. However, there are a few differences between credit cards and lines of credit. One is the fact that you will get a higher credit limit with the latter compared to credit cards. Additionally, the interest rates are far lower, although credit cards do come with some perks, which you may find attractive.

Lines of credit can either be secured or unsecured. You can pick the choice that works best for your situation. Consider your current financial circumstances and preferences. More importantly, you need to have an eligible asset if you plan to go for a secured line of credit.

Unsecured lines of credit are great for those who find asset requirements to be a big hassle. However, if you can provide an asset as security for the loan, you have an increased chance for approval. It also means you can get a lower interest rate while enjoying a higher credit limit, depending on the value of the security asset. Examples of assets accepted as security are cars, houses, or commercial properties.

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Benefits of Lines of Credit

If you cannot seem to make up your mind about whether or not you should apply for a line of credit, a simple solution is to compare its advantages and disadvantages.

Let us take a look at the benefits first:

  • When your line of credit application is approved, you can quickly gain access to funds.
  • The funds are available whenever you need to use them. 
  • Lines of credit are flexible, allowing you to use the funds for a variety of purposes, including bills payment, loan refinancing, luxury holiday, and wedding expenses.
  • There’s no need to submit a credit application whenever you need to withdraw funds.
  • You only have to take note of the funds you withdraw and not the entire balance or credit limit. The amount you use is the only thing you need to pay for, along with interest, of course.

There are some lines of credit that are linked directly to your debit card. This feature allows more flexibility when it comes to how you use the money.

Disadvantages of Lines of Credit

Above, you will see that lines of credit are an attractive option. However, the following drawbacks may prompt you to reconsider:

  • Lines of credit are not free. You are essentially borrowing the credit limit, which means you need to pay for interest.
  • Aside from the interest, you should also be mindful of the other fees and charges associated with the account.
  • Lines of credit often come with an annual fee, monthly service fee, establishment fee, and other charges.
  • You will have to pay the annual fee and other charges even if you do not spend anything against your credit limit.

A big disadvantage with having a line of credit is that you could end up spending more than you should. Because you have access to funds that replenish themselves each time you repay, you might be tempted to spend money unnecessarily.

Is a Line of Credit for You?

If you need continued access to funds and the set credit limit is enough for your specific purpose, a line of credit may be what you’re looking for. On the other hand, if you want to make a large purchase, a personal loan may be more suitable. It’s also the better option if you require funds for a single expense.

It’s a beneficial choice for business owners needing assistance in managing their cash flow. If you run a business, you could find yourself fearing unexpected costs. It helps ease your worries when you know that you have access to additional funds even during an unforeseen event. However, be sure that you can pay off the loan quickly, typically every month. You should also know that the credit line has a higher interest rate for businesses.

Which type of loan do you think fits your situation more? Is it a personal or commercial line of credit? Perhaps you would rather opt for a traditional loan, which is often viewed as a straightforward option. No matter what your answer is, Loans Unlimited has got you covered. We offer both a personal or commercial loan and a line of credit. Get in touch with our loan specialists today to learn how we can help.