The first step toward determining whether you need to establish a new line of credit is by understanding the basics. To start off, that means asking yourself, what is a line of credit?
In short, a line of credit provides access to a limited amount of funds, allowing you to borrow as little or as much of that amount as you need. Once approved for a line of credit loan, borrowers can think of themselves as their own bank, as they gain full access to those funds whenever they need it.
By definition, lines of credit allow borrowers to choose when and how much they withdraw. Lines of credit are fundamentally different from traditional loans, because they allow borrowers to withdraw repeatedly from their line of credit, as long as they don’t exceed their credit limit. While lines of credit provide significantly more flexibility than other lending options, they often have higher interest rates than traditional loans.
Deciding whether a line of credit is the right lending product for you depends on your needs and circumstances. Read on to decide whether a line of credit is a good option for you.
Convenient, flexible credit for big expenses
Once lenders assign a maximum credit limit and establish a timeframe for a line of credit, borrowers can repeatedly tap into it to pay for expenses big and small, like home improvement projects, unexpected car maintenance, educational costs, medical bills and debt consolidation. Line of credit accounts provide plenty of flexibility, allowing borrowers to access funds through card, checks, online transfers and bank withdrawals.
Flexibility makes this lending option a popular consumer choice. It gives borrowers easy access to money they can withdraw whenever they need more — unless they reach their credit limit. Interest accrues once you draw on the loan, so it’s wise to at least keep up with the minimum monthly payments. However, only paying the minimum amount for a variable-rate line of credit will ultimately cost you more in the long run because of the interest payments.
Qualifying for a variable-rate line of credit
With personal lines of credit, you typically pay a variable rate that’s tied to the U.S. prime rate; while the interest rate can fluctuate in correlation with the market, it’s not likely to spike like the increases possible with an adjustable-rate loan.
Most personal line of credit loans are classified as unsecure or uninsured, meaning collateral isn’t required to qualify for the loan — unlike home equity lines of credit (HELOC), which use your house to secure the financing and therefore offers lower interest rates. Lenders usually require both a good credit score and repayment history to approve a line of credit loan.
Paying off a line of credit loan
A line of credit loan also offers flexibility on how you pay off the amount borrowed. It can be repaid through flexible terms over a period of time, or you can pay the outstanding balance all at once. Before opening any line of credit, ensure the lending institution does not charge a prepayment penalty for early payoff.
Three kinds of credit lines to consider
- Credit cards: Credit cards are one of the most common examples of unsecured lines of credit. Credit cards are primarily used for everyday purchases and relatively small, unexpected expenses. As an unsecured line of credit, credit cards usually have high interest rates. Cash advances on credit cards also come with high fees, and payment delinquency can result in penalties and increased interest rates.
- Home equity line of credit: Also known as a HELOC, a home equity line of credit is a secured line of credit, meaning it’s backed by the value of your home. Your HELOC credit limit is calculated based on the current value of your home, minus the amount you still owe on the mortgage. Since it’s a secured line of credit, you can usually get a lower rate than what an unsecured line offers. With low, interest-only payments, you can choose to pay the minimum amount, pay extra at any time or pay it off early without penalty.
- Personal line of credit: Personal lines of credit are generally unsecured, which means interest rates are often higher than what HELOCs and other secured lines of credit offer. If approved for a personal line of credit, you receive access to a predefined sum you can use as needed. Like a HELOC, you only pay interest on the amount you withdraw, and the interest rate is variable. You can choose to pay off your balance through monthly payments or all at once.
Ready to learn more? Consult one of our trusted lending experts today to discuss loan solutions with First Merchants. Call 1.800.205.3464 or get a free credit line evaluation and consultation.
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