Most people need to borrow money from time to time, and a line of credit is one of the most common ways to access the funds.
You’ve probably heard the term before, and you’ve almost certainly used them.
They can deliver positive results, but financially responsible individuals must also be wary of their potential dangers.
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What is a Line of Credit?
A line of credit, otherwise known as a LOC, is a financial tool that confirms a financial agreement between a consumer (you) and a financial institution (usually a bank), allowing you to instantly borrow money up to the value of a pre-approved limit.
Lines of credit can be secured (such as a home equity loan) or unsecured.
The most likely products that you’ll encounter are:
- Credit cards,
- Store cards,
- Bank overdrafts.
However, other lines of credit products do exist.
They offer a more flexible solution than a loan in regards to how much is borrowed at any time, as well as the repayments.
How it all Works
While the exact process can vary depending on the lender and the product being used to form your line of credit,the fundamental process is as follows:
- After making an application to gain a line of credit, the lender will confirm the terms of the agreement, including the maximum limit that can be borrowed.
- When deemed necessary, you will use your LOC to pay for services or products.
- Once this happens, you are committed to repaying the debt and any interest incurred as a result of using the line of credit.
The Dos & Don’ts of Using a Line of Credit
Like most financial tools, lines of credit are neither good nor bad.
Ultimately, it is a tool that can have a positive impact by providing a financial safety net, but only when it is used in a responsible manner.
It’s important to understand the Dos and Don’ts to maintain good financial health.
Some of the key issues are listed below:
- Do use a line of credit to consolidate smaller high-interest debts, as long as you know that you can clear the debt on the line of credit in an efficient manner.
- Do use the LOC when you can pay back the full balance within a few days. For example, if your payday has been delayed due to a national holiday.
- Do investigate whether the interest paid on the line of credit is tax-deductible. This is most commonly found when using a secured HELOC to fund home improvements.
- Do not use a LOC if you need to borrow a set amount for a one-off purchase as a traditional loan will probably offer better repayment terms.
- Do not use any credit if you are unable to meet the minimal monthly repayments each month, or if you are likely to fall into the trap of only paying the minimum payment.
- Do not use a LOC for luxuries like holidays or nights out, as this will lead you into even further financial problems.
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