If you require some flexibility to finance a long-term project, then a line of credit may be the tool you are seeking. Available to individuals and businesses, a line of credit works in a similar fashion to a credit card but typically has lower interest rates and higher credit limits. Why not test yourself by taking this quiz before you decide whether this type of loan is for you.
A line of credit is a loan where you have a fixed maximum limit and write checks as needed over several years. A line of credit gives you flexibility to finance long-term plans without making payments on more money than you need to use immediately.
The main advantage to using a line of credit is that interest rates are much lower than on a credit card. The credit limit on a line of credit is also much higher.
With a secured line of credit, you give the lender the right to seize designated collateral if you fail to make the loan payments.
The advantage of an unsecured line of credit is that you are not required to have collateral or to put your possessions at risk in order to obtain the loan. A disadvantage is that you will pay a higher interest rate because the lender has more risk.
Instead of making payments on the entire loan principal that is available, you only have to make payments on the credit used. Technically, you are borrowing only the amount you need without constantly being required to apply for loans.
Lines of credit fall into two main types: personal line of credit and business line of credit. Both types function in a similar way.
A typical secured personal line of credit is called a home equity line of credit (HELOC). You secure a loan based on the market value of your home.
With a HELOC, you have a set period of time that you may draw funds from the line of credit called a draw term. The draw term is usually around 10 years.
A line of credit is a perfect tool for financing a series of undetermined medical costs. If you are planning a trip to Las Vegas it would be wise to leave your line of credit checks in a safe place at home.
Most lines of credit charge a variable interest rate based on the prime rate plus a fixed margin. The interest rate will always be the prime rate plus the agreed upon fixed margin.
The best reason to arrange interest only payments on a HELOC is in the situation where you will receive enough money, such as an inheritance, to pay the principal at the end of the draw term. With the other two choices you could find yourself owing the full amount at the end and unable to pay it.
A home equity loan is usually referred to as a second mortgage. A home equity loan is a lump sum loan with interest and rates of payment established upon signing the loan.
Lenders typically require a business to secure their line of credit with business assets. Business assets include such items as computers, furniture and vehicles.
Business lenders will look at a business to assess profit and loss history as well as future business risk before approving a business line of credit. They will also check for other risks that the business may be taking such as an investment in questionable technologies.
The factor that has the greatest impact on interest rates charged on lines of credit is the prime interest rate charged by the U.S. Federal Reserve. The Federal Reserve uses many variables to determine what the prime rate will be at any given time.