Line of Credit refers to a type of loan that lets you borrow money up to a certain limit. It is also known as Revolving Credit. You can use the funds as and when needed, up to the specific limit. In turn, you will have to pay the loan back at any time with additional interest that you are charged. The interest charged starts from the day you borrow the money. Every time you borrow money, your credit limit drops, but once you pay off the credit, your credit limit goes back up. A credit card is the best example of line of credit. In a survey conducted by the Financial Consumer Agency of Canada, an average of 85% of Canadians depends on credit cards. Other examples are home equity line of credit (HELOC) and business lines of credit.
Using line of credit comes with certain advantages and disadvantages.
Advantages:
- The best advantage is having money when you need it. You don’t have to apply and wait for a loan every time you lack the finance to purchase something.
- Depending on your credit limit, you can use as much as you want from buying a pack of gums to an expensive snowboard.
- You can buy virtually anything as long as you have the credit limit. You can purchase a house or vehicle with your line of credit. Many people use it for home improvement projects or to fund their vacations.
- Line of credit offers a great solution for those who have a steady job, but irregular paychecks. This may apply to a salesperson or someone who has started a small business and whose income flow depends on the season.
- Interest rates are much lower than those of loans.
- There are no fees or penalty charges for paying off your credit before time, depending on the financial institution you open the line of credit with.
- If you open a line of credit in a financial institution where you already have a bank account, you can set up the line of credit, so that any overdraft on your bank account is transferred to the line of credit, avoiding any unnecessary fees.
Disadvantages:
- Temptation is the biggest disadvantage. As a consumer, you will have the temptation of spending money you don’t have. Once the line of credit is maxed out, you may even open another one and max that out too. Hence it is also known as revolving credit. This may get you into serious debt and financial trouble.
- At times the flexibility of the line of credit will work against you, if you don’t regularly pay it off. Interest will pile up and add up to a large amount.
- Often written in fine print for some lines of credit, the lender can change your credit limit and interest rates. This means if the lender wishes it, your credit limit and interest rates can be changed.
- Paying off the credit may not mean that you are paying off the main balance, but only paying off the interest rates. This will result in you taking a long time to pay off the loan.
- Some lines of credit require collateral. Generally, property such as a house is used as collateral. This is dangerous considering that if you are unable to pay off the credit, the lender can legally acquire your house.
