You might have heard about a line of credit as a way to fund your personal or business needs. But what exactly is it?
Check out answers to some of the top questions when it comes to lines of credit.
How Can I Use a Line of Credit?
A line of credit is an open-ended loan with a lender that can be utilized for any purpose allowed under the lending agreement (or promissory note). Often, you can use a line of credit as financing for home improvements, wedding and event vendor deposits, debt consolidation, medical costs, and other expenses that require funds you don’t have readily available. “This makes it more convenient [than a regular loan] when your borrowing needs arise suddenly,” says Chris Evans, Assistant Vice President Direct Lending Manager, Regions Bank. “You don’t have to submit a new request for financing since the line would already be available.”
What’s the Difference Between a Line of Credit and an Installment Loan?
You might choose a line of credit when you have multiple borrowing needs because the annual fee for a line of credit is cheaper than paying processing fees for more than one installment loan, says Evans. A loan offers a single disbursement, and your relationship with the loan provider ends once you’ve paid back the money. A line of credit has a fixed limit of what you can borrow, but as you pay off what you’ve used, the line opens up again.
With a line of credit, you’ll only make payments on the amount outstanding, and you can take out money when you need it instead of in a lump sum. If your balance is small, your payment may also be smaller than installment loan payments, which don’t fluctuate. But, keep in mind if you make only the minimum payment each period, you will pay more in interest, and it will take you longer to pay off your balance. On the other hand, an installment loan usually has fixed payments for a set time period for the cost of the total loan.
What’s the Difference Between a Secured and Unsecured Line of Credit?
A secured line of credit means you’re using an asset as collateral to secure the line, and the lender can seize the asset if you don’t repay the debt according to the lending agreement terms. An unsecured line of credit means you aren’t using an asset as collateral — but typically comes with higher interest rates to insure against the risk of default. For a secured personal line of credit, the lender may agree to use your savings account as collateral. A home equity line of credit is a secured line of credit that uses the equity in your home as collateral, so you would generally need to have a certain amount of equity in your home to get a HELOC.
When Should I Consider a Line of Credit?
A line of credit might be preferable if you need flexible financing or have a recurring credit need. However, a line of credit may have higher, more variable interest rates than a fixed installment loan, which comes with a fixed rate and a set payment schedule. An installment loan will have fixed monthly payments, so you’ll always know how much to budget for in your financial plan. Make sure you consider the advantages of each option before you make the right decision for your borrowing needs.
