What is a Line of Credit?
But what exactly is a line of credit? How do they work? And how are they different from the good old personal loan or credit card?
We answer each of these questions and more below.
On this page:
What is a line of credit?
A line of credit is a flexible product allowing you to access funds up to a predetermined credit limit as needed. It’s very similar to a credit card in that it functions as a revolving credit facility: you don’t have to draw down the total amount you’ve been approved to borrow and only have to pay interest on what you’ve used instead of the whole amount.
If, for example, you applied for a $2,000 line of credit and initially only needed to use $500, you wouldn’t have to pay interest on the remaining balance ($1,500) yet. A line of credit offers you flexibility in what you choose to borrow and how much you need to repay.
What can you use a line of credit for?
Since a line of credit is a flexible product, you can use it for almost anything in most cases, with a common reason being everyday expenses. If you need quick funds to pay for key items like groceries and fuel, a line of credit can provide the funds you need when you need them.
As long as you meet the eligibility criteria and qualify for the line of credit, you can also use one to pay for emergency expenses as they arise. For example, you could also use a line of credit to pay for an urgent car repair if you need your car to drive to work.
Line of credit 101: rates, fees and more
Lines of credit are very similar to other credit products, which means they also come with the usual: fees, interest rates, loan terms etc.
Line of credit interest rates, fees and charges
With a line of credit, the interest rate applies to the amount borrowed but is only charged on the balance used. Because of this, the interest rate on a line of credit is often higher than the typical personal loan or credit card.
You can also be charged the following common fees on a line of credit:
- Establishment fees: Similar to a personal loan establishment fee, this fee may be charged to cover the costs of assessing and approving an application for a line of credit. It may be charged separately or added to your overall loan amount.
- Annual or monthly fees: Lenders may charge an annual fee to maintain the line of credit account. Others might come with a monthly fee; depending on the lender, this could be charged regardless of whether you actually use the money.
- Withdrawal fees: Also known as a withdrawal fee, some lenders may charge a fee for each withdrawal made from the line of credit.
- Late payment fees: Failing to make timely repayments may lead to a late payment fee.
Note that each lender will have different fees and charges for each, and some won’t charge anything.
Line of credit loan amounts
The approved credit limit for a line of credit can vary based on the lender's policies and the borrower's creditworthiness. These credit limits can range from a few thousand dollars to a higher amount, but you can often borrow just a few hundred dollars at a time, providing the flexibility to borrow as needed within the approved limit.
Line of credit loan terms
Line of credit loans generally follow a revolving credit structure, so there isn’t a set loan term initially. But once you draw down on the line of credit and use the funds, you’ll have to repay this amount within a specific period, often with a minimum monthly repayment.
Are lines of credit secured or unsecured?
A secured line of credit requires collateral, such as a home or other valuable asset, to back the credit limit. For this reason, secured lines of credit are often called home equity loans if you borrow a larger amount.
On the other hand, unsecured lines of credit do not require collateral, but they may have higher interest rates than secured options.
What are the alternatives to a line of credit?
Two of the products a line of credit is most commonly compared to are personal loans and credit cards.
Line of credit vs personal loans
Personal loans provide a lump sum amount you receive upfront and repay in fixed instalments over a period set out in your loan contract, known as the loan term. You’re charged interest on the full amount from the get-go, compared to the line of credit only charging interest on the amount withdrawn.
Personal loans often come with higher maximum loan amounts than lines of credit, so you can use them for more significant expenses when needed.
Line of credit vs credit cards
Credit cards offer a revolving credit facility similar to a line of credit, and for all intents and purposes, are almost exactly the same thing. The key differences will lie in the interest rates, fees, credit limits and other loan terms, which can vary between providers.
Line of credit pros and cons
All financial products have advantages and disadvantages, and lines of credit are no exception. We’ve outlined the pros and cons of a line of credit below.
- Flexibility: You can access funds whenever needed, making it a good option for unexpected expenses.
- Revolving credit line: The ability to borrow, repay, and borrow again without reapplying can be helpful for ongoing financial needs.
- Improve your credit score: If your lender has Comprehensive Credit Reporting (CCR), you could improve your credit score steadily by making repayments on time and in full.
- Financial safety net: If you can avoid overspending (see ‘cons’ below), then a line of credit can provide funds quickly when needed. It might be worth checking if you can find a lender who won’t charge a monthly fee if you don’t use your line of credit.
- Fewer fees: A Line of credit may (depending on the lender) charge fewer fees than a standard personal loan.
- Potentially higher rates: That extra flexibility can come at a price. Compared to a typical credit card or personal loan, lines of credit can have higher interest rates in many cases, particularly if they’re unsecured.
- Late payment penalties: Read the terms and conditions carefully to see what you could be charged if you miss a repayment. Once you withdraw from your line of credit, you must repay that amount within a set time frame. Missing these deadlines could cost you a lot more than you bargained for.
- Your credit score could be impacted: You can potentially damage your credit score if you don't make your payments on time.
- The temptation to overspend: Because your funds are easy to access, you could be tempted to spend more than you actually need and accumulate excessive debt.
- Lower credit limits: Mostly true for unsecured lines of credit, the maximum credit limit might be lower than personal loans and some credit cards.
Is a line of credit right for me?
The answer to this question will depend on your specific circumstances, but for the typical person, a line of credit could be the right option if:
- You’re looking to borrow a smaller amount
- You need the funds to pay for everyday or emergency expenses
- You want to draw down the funds in increments instead of borrowing the whole amount all at once
- You don’t want to make a new application every time you need some funds
- You prefer flexibility over rigidity in your repayment schedule
- You’re responsible with your money and won’t miss your repayments or be tempted to overspend
On the other hand, if you need to borrow a larger amount for a bigger expense, such as a home renovation or wedding, you might be better off applying for a personal loan instead.
At Jacaranda Finance, you can borrow up to $25,000 and for as long as 48 months, with fixed interest rates to help you budget.
No matter which option you decide to go with, make sure you compare rates, fees, loan terms and more from different lenders, and decide which product best suits your own financial needs.
The information on this website is for general information only. It should not be taken as constituting professional advice from the website owner - Jacaranda Finance. Jacaranda Finance is not a financial adviser, and the content on this page does not take into account your objectives, financial situation or needs. You should consider seeking independent legal, financial, taxation or other advice to check how the website information relates to your unique circumstances.
Jacaranda Finance is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly by use of this website.
You can get in touch with William via email@example.com.