Many people are familiar with the idea of a credit card: a plastic card used to retrieve money a bank loans out and pay back later.
A line of credit is like a credit card, but there are some fundamental differences between them. One example of this is that credit cards could be used indefinitely in theory.
Lines of credit, on the other hand, often have a fixed amount that can be borrowed. Despite this, taking lines of credit have unique advantages, making them attractive to those who would like a limit on their spending.
Reasons Why You Might Create a Line of Credit
Because a line of credit allows you to borrow a fixed amount of money, it provides much more flexibility than a credit card or a personal loan. The three type of credit lines include:
- Revolving, such as a credit cards. Learn more about revolving lines of credit in the section below.
- Installment, which is a one-time fixed amount that has monthly payments such as a mortgage.
- Open, such as charge cards, which must be paid in full each month.
Choosing a line of credit gives you the freedom to choose the amount you want to borrow, which is often more than a credit card company would offer. For instance, a bank may issue you a credit card with a maximum limit of $20,000 but a home loan for $200,000.
This method of credit also makes it easier to get cash advances. For example, funds from a personal loan can pay utility bills, which often do not accept credit card payments.
Eligibility for Receiving a Line of Credit
Even though most people are eligible to receive a line of credit, there are some details that can make an application more appealing to a lender. The most important factor is to establish credibility and trust with the lender.
In order to do this, the borrower must have a good credit score since it provides the lender with proof that the borrower has been responsible with his or her credit in the past. Paying back the loans in a timely manner is important to lenders, so observing credit score should be a priority.
What are revolving and non-revolving credit lines?
Various types of credit lines have unique features, which may be beneficial or restricitve depending on your need. When exploring the different types of lines of credit and their respective features, it is important to weigh which one is right for you. Because of the unique features to a line of credit, each method of credit can help in different ways.
Eligibility for revolving or non-revolving lines of credit will depending on the lender. For instance, you may only be able to obtain a line of credit for those with bad credit specifically if your have a poor financial history.
Revolving Lines of Credit
A revolving line of credit is very similar to credit cards because consumers can pay for many goods or services up to the maximum amount. When the borrower pays his or her credit bills in a timely manner, then they may reuse the borrowed funds.
These are known as “revolving” accounts because the account resets to its original limit every month or after each billing period. The borrower may continue to use a revolving line of credit indefinitely so long as the borrower does not surpass the limit during any one billing period.
The creditor will increase the maximum the borrower is allowed to withdraw with time as he or she proves reliable. The increased maximum can also help improve the credit score of the borrower.
Non-Revolving Lines of Credit
While revolving lines of credit are comparable to credit cards, non-revolving lines of credit are comparable to student loans or even auto loans. Once the borrower has paid back all the funds with interest, the line of credit cannot be used again.
This credit line is somewhat less flexible than the revolving line of credit because it does not reset to its original limit at the end of a billing period. This inability to reset its amount means a non-revolving credit line is a temporary service.
Once the maximum account has been withdrawn and all the credit bills have been paid back, then the line of credit will close. If necessary, then it is possible to apply for another credit line.
What are secured and unsecured lines of credit?
Another factor that separates certain lines of credit is their level of security for the lender.
Unsecure Credit Lines
A line of credit that is very popular for personal use is an unsecured credit line. Even though their name may suggest otherwise, an unsecured line of credit can be more secure for a consumer to use and can be used in varying circumstances.
The reason this is called “unsecured” is because the party that is taking more risk is the lender. When the borrower begins his or her line of credit and is able to access their money, he or she does not have to provide collateral to the lender. Accordingly, the borrower does not lose anything when he or she fails to pay back their monthly credit bills with an unsecured credit line.
Because of this increased risk for lenders, unsecured lines of credit can be more difficult to obtain and have higher monthly interest rates than other types of credit lines. This increased interest rate is to make up for the increased level of risk on the part of the lender. The difficulty of obtaining this also makes it more likely that only reputable businesses or individuals with high credit scores can have access to this line of credit.
Credits cards are considered unsecured lines of credit as well because they do not need additional collateral.
Secure Credit Lines
On the contrary, secured lines of credit are more secure for lenders but are not as convenient for borrowers. The boworrer will need to place something, usually property, as colleteral to obtain a loan. In the event the borrower fails to repay the loan, the lender has rights to the colleteral.
Home Equity Line of Credit (HELOC) is an example of a secure line of credit that is used if you need an addition to your home, a repair or any other unexpected expense for your home. Just like any line of credit, you may take out needed funds and pay them back every month until all the borrowed amount has been repaid.
The reason HELOC is known as a secured account, however, is because borrowers are putting the appraised value of the home as collateral. Failing to pay monthly bills for HELOC means that borrowers are risking forfeiting their homes.
Common HELOC Loans
Applying for a Line of Credit
Fulfilling the eligibility requirements can ease the search for finding the right lender for you. The requirements include but are not limited to having:
- A good credit score.
- A responsible credit history.
Credit lines can be found at bank or credit union as an alternative for credit cards. Because every line of credit, its requirements and maximum amounts can vary, you should look carefully to find what option best aligns with your needs.