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Line of Credit: A Quick Overview

Mar 04, 2022 By Susan Kelly

When people are strapped for cash, the last thing on their minds is applying for a line of credit. Going to the bank for a standard fixed- or variable-rate loan, using credit cards, borrowing from family members, or turning to specialist peer-to-peer or social lending and donation websites on the internet is what comes to mind first.

Pawnshops and payday lenders are available in the most desperate of situations. Credit lines have been used for years to fulfill working capital needs and take advantage of strategic investment possibilities in the business world. Still, people haven't taken advantage of this strategy.

It's possible that banks don't publicize lines of credit, and borrowers don't realize they exist. A home equity line of credit, or HELOC, is the only option for borrowing money. Of course, since the borrower's house is acting as collateral, it comes with its own set of complications and dangers.

A bank's earning asset management is a little more complicated with lines of credit than with credit card loans because the outstanding balances can't be regulated once the line of credit is approved.

For most consumers, unsecured, one-time personal loans from banks aren't something they'd be interested in taking out. Similarly, taking out a loan, paying it back, and then borrowing again is not a cost-effective strategy for a borrower. Lines of credit solve both of these problems by allowing borrowers to access a predetermined amount of money whenever they need it.

When to Use a Line of Credit

There are many purposes for lines of credit, but they aren't meant to be used to buy a house or a car. Instead, lines of credit can be used to buy things that a bank wouldn't ordinarily lend money for.

Individual lines of credit are most often used for the same basic purposes as company lines of credit: to smooth out the vagaries of fluctuating monthly income and expenses or to finance projects where it may be impossible to determine the exact funds required in advance.

Suppose you're a self-employed individual who gets paid each month irregularly or who has to wait a long time to get paid for work you've already done.

A line of credit might be a more cost-effective (it often offers lower interest rates) and more flexible choice than the person's traditional reliance on credit cards to deal with cash flow constraints.

As a result, when big deposits of cash are required, such as during weddings, or other special occasions where the total cost may not be known in advance, or the seller may not accept credit cards, lines of credit might be a practical option.

The housing boom also saw a rise in credit lines to finance home remodeling and refurbishment projects. People typically obtained a mortgage and a line of credit at the same time to cover the cost of any upgrades or repairs that were required.

The Drawbacks Posed By Credit Lines

Lines of credit can be both beneficial and harmful, just like any other type of borrowing. If investors use a credit line, they must repay the money they borrowed. As a result, applicants with less than stellar credit will have a more difficult time getting authorized.

In the same way, it's not a gift. Although unsecured lines are less costly than loans from pawnshops or payday lenders and usually less expensive than credit cards, they are more costly than standard secured lines of credit like mortgages or automobile loans. In most circumstances, interest on a line of credit is not deductible from income taxes.

If you don't use the line of credit, the bank may impose a monthly or annual maintenance fee, and interest begins to accrue as soon as the money is borrowed. Some borrowers may be shocked by the amount of interest they pay on their lines of credit because these loans can be called on and returned on an as-needed basis.

Lines of Credit's Purposes

In addition to being flexible and useful for nearly anything, personal lines of credit can cause serious financial problems if they are not paid back on time. That's still the case.

Personal lines of credit are most commonly used for home improvement projects. Still, there are several other circumstances in which the interest rate and flexible repayment options (along with the possible, game-changing annual fees) make lines of credit worth considering.

Among The Possibilities

  • Projects that face financial difficulties: Your daughter's wedding coincides with replacing the roof. To pay for both, a LOC may be an option.
  • Inconsistently paid workers: You are self-employed or work on commission, and your next payment won't arrive for another month. Paying regular monthly bills while drawing on a credit line is a convenient way to make ends meet until your next paycheck arrives.
  • Situations that necessitate immediate attention: Your child's college tuition and your credit card payments are both dues at the same time as your tax bill. A line of credit can help you consolidate your debt.
  • A line of credit (LOC) can provide overdraft protection if you are a frequent check writer with fluctuating revenue.
  • Business opportunity: A credit line can be used as collateral if you wish to buy a business or boost its growth by advertising, marketing, or attending trade events.
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