The 6 Things You Need to Know About Getting a Line of Credit

When you consider applying for a line of credit, it is essential that you learn more about credit lines and how they can affect you first. There are several types of credit lines available, and each is either considered a secured or unsecured loan.

However, while sharing some similarities with traditional loans, credit is a particular type of borrowing with its own draw amount and repayment period.

Line of credit rates vary by type. For example, a secured line will typically include far more favorable interest rates in comparison to an unsecured line. Therefore, it is vital to learn more about the critical differences between these two borrowing terms to make an informed decision.

It is also essential to compare all the options that might be available to you. Once you are ready to apply, you can save money on interest rates and maximize the benefits of credit lines by following a few simple steps.

1. What is a line of credit and how does it work?

If you are wondering, “What is a line of credit?” then it essential to understand that, unlike traditional loans, a credit line is a revolving source of funds that you may borrow as you need it.

After you are approved, you are generally not required to borrow funds or pay any interest right away. Instead, you can choose when to borrow and begin to pay interest fees as part of your repayment period only after you have withdrawn funds.

Once you have paid off the money that you borrow, you can borrow more as you need it. You can also continue to borrow money from your line of credit while repaying the amount that you already owe during your draw period.

Your draw period is a specified amount of time where you may continue to borrow more money. Having a draw period offers several key benefits.

For example, if you are using your line to fund a home remodeling project, then you may not know how much to borrow right away. With a credit line, you could borrow more money as you need it.

2. The Difference Between a Secured and Unsecured Line of Credit

An unsecured line of credit refers to a type of credit line that may not require any form of collateral. Unsecured loans:

  • Often have far lower maximums.
  • Are associated with higher interest rates, due to the increased risk to the lender.
  • Are more difficult to qualify for an unsecured credit line if you do not have an adequate credit score.

Meanwhile, a secured line of credit is a type of credit line that requires you to put up some form of collateral to hold you to repayments, such as your home or vehicle. In some cases, you may be able to use a certificate of deposit or a bank account as collateral. Secured lines:

  • Are less risky to lenders because the lender can foreclose upon or repossess your collateral, should you fail to repay your loan or follow the terms of your loan.
  • Pose a higher risk to you.
  • Are typically easier to qualify for.
  • Are often granted higher borrowing amounts.
  • Include more favorable interest rates for borrowers.

3. What is home equity line of credit?

A home equity line of credit (HELOC) is one of the most common types of credit lines. This secured credit uses a home’s current equity as collateral for the loan.

The credit limit for this particular line is determined by the loan-to-value ratio of the house, your credit score and income. Before applying for any type of loan, check your credit report and score, which you can do for free once a year.

These line of credit rates are often low compared to other types of credit lines and loans. This is due to the decreased risk to lenders, as borrowers generally repay any money borrowed in full to avoid foreclosure on their home.

Image from CreditOne Bank

4. Reviewing Other Common Types of Lines of Credit

Most commonly, a line of credit is provided through traditional credit cards. Credit cards allow you to borrow up to your maximum limit, and you are expected to make payments towards your principal balance and accrued interest.

Like other forms of credit, you can re-borrow multiple times. However, one significant difference between credit cards and personal credit lines such as HELOC is that credit cards have higher interest rates on average.

Depending on your financial institution, you may already have another type of credit line available to you. Several banks provide overdraft credit lines for checking accounts that are overdrawn.

This allows a purchase or payment to be completed rather than denied, even if no funds are readily available. However, these credit lines are small and usually incur an overdraft fee.

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If you have a low credit score or a high debt-to-income ratio, for example, then you may be offered a high-interest rate that will cost you more. Therefore, you can save more by holding off on an application until you have the opportunity to better your credit score or improve other areas of your finances.

5. Considering a Line of Credit vs. Loan

It is essential to weigh a line of credit vs loan if you are deciding between a credit line and a traditional loan. Unlike credit lines, loans provide you with a one-time lump sum towards a more significant expense, such as the purchase or a home or vehicle.

Interest rates are usually fixed, but they can vary based upon your credit history, credit score, income, debt-to-ratio and other factors. Loan terms are based upon several factors as well, including the amount of the loan.

Unlike with lines of credit, once the loan has been repaid, it cannot be borrowed from again. As such, credit lines are better used for revolving expenses rather than one-time, large purchases.

It is always essential to review rates of all the options that may be available to you. Doing so will help you save money on interest rates and other fees.

6. Tips for Making the Most of a Line of Credit

If you are considering a line of credit or a loan, then it is crucial that you review your credit score, credit history, income and debt-to-income ratio. All of these factors will have a significant impact on the type of terms that you are offered.

The three credit reporting bureaus that monitor your credit include:

If you have a low credit score or a high debt-to-income ratio, for example, then you may be offered a high-interest rate that will cost you more. Therefore, you can save more by holding off on an application until you have the opportunity to better your credit score or improve other areas of your finances.

Image from Credit One Bank