A line of credit is excellent when your rainy day fund just isn’t going to cover you from the storm in your life. This form of lending made its breakthrough in the corporate world. Businesses used the injection of capital to make strategic, bold business moves; such as a factory expansion when higher sales were forecasted, but resources would not be able to keep up with demand.
These days elements of personal financing have become much more straightforward; what with online banking and helpful apps that streamline personal money management (my top five are listed here). However, not only are there so many lenders on the market, but there are so many products as well. It’s good to know the basics of the major products that are available to you. That doesn’t mean that you need to be a guru or spend all day looking up the new readvanceable mortgage schemes that may or may not be rolled out in the next few years. That’s why we take so much pride in this blog. We are here to provide you with a no-nonsense, condensed and useful approach to managing your credit in a way that is both sensible and favorable to your situation.
The Highlights of a Personal LOC
Personal loans, payday loans, and even credit card credit limits can keep your head above water, but you’re likely to feel the pinch in the form of high-interest rates, for some time afterward. Personal lines of credit, on the other hand, offer lower rates of interest. A personal LOC is a loan that you apply for but only take out what you need. You are not required to pay interest on the portion of the loan that you don’t access. This feature gives you peace of mind and I’ll give you examples of situations where this loan comes into its own.
You’re also looking at a higher limit than a credit card or personal loan. As with all credit services, the higher your credit score, the more you’re going to be offered. Another significant bonus is the ease of access. The loan can be withdrawn instantly from an ATM.
It’s also a great option if you know you have a lot of expenses coming that are a one-time thing. One typical example is a wedding. Cash deposits have to be placed left, right and center for florists, hotels, and photography. You politely expect a little bit of cash to come, in the form of wedding gifts, but to tide you over a line of credit works out much cheaper than digging into your credit card limit.
Why are interests rates lower in a LOC than a loan?
First off, Banks don’t want to have to fill in the forms for every loan you wish to take out over the space of a few years. It makes much more economic sense to give you a credit threshold and allow you free reign on that money provided you make the repayments.
In what situation should I get a personal LOC?
I’m going to go back to the wedding scenario. So you’ve budgeted all the elements of your wedding and decided that you’re going to need an extra $15,000. If you apply for a personal loan on that amount, you get the full value of the loan but have to begin repaying interest on the total amount immediately. You start your repayments but realize that you forgot to invite a few friends and your uncle and haven’t accounted for them in your budget. You also forgot to organize a band for the night and suddenly find yourself grappling for an extra $2,000 for the event.
Here’s where an LOC would have worked much better for the couple. They could have applied for a $20,000 LOC giving them some wiggle room. Anything they didn’t spend would not incur interest. The same can be applied to renovating a kitchen and other projects that need to be done around the house.
Lines of Credit
In this section, I’m going to run you through the most common types of LOCs.
Secured LOC. In this scenario, you’re giving the lenders collateral against your loan. The upside to this is that you’ll be getting a more competitive interest rate and a higher credit limit than if you were going to choose the next option.
Unsecured LOC is much more challenging to get approved by banks, and you’re looking at a higher interest rate and a lower credit limit than a secured option. The bank or lending institution has to account for the higher risk they are taking in this scenario. However, not everyone has a significant asset to provide as collateral, and you still get a better offer than a regular personal loan.
Home Equity LOC. Here we are looking at using the equity value of your home or a second mortgage as a lien for the lender. This LOC is a type of secured loan and bases the loan’s capacity on your home’s appraised value.
Student LOC. Specifically geared towards paying for education.
Top three tips for taking out an LOC
- Make sure to check whether your bank charges a maintenance fee on your LOC. Most don’t, so if the offer you’re getting has an annual fee, I’d suggest looking around and seeing if you can find a better dealer.
- Taking out an LOC and making repayments on time improves your credit score. This will make future loans more affordable, so if you’re looking to take out a mortgage, car loan, or other significant loans over the next few years, this is a shrewd strategy. Needless to say, failing to make repayments is going to hurt your repayments.
- Keep yourself accountable. It can be all too easy when given access to a potentially large sum of money to becoming frivolous and throw caution to the wind. Only spend what you know you can pay back. This is not free money after all.
This information is just our view and should be not be considered advice of any sorts.
From our experience and other professionals we partner and engage with, we work to find useful tips and information that would be important to share.
If you are someone that is looking for professional advice tailored to your circumstance, please contact a bank, financial advisor, or mortgage broker.