The Basics of Lines of Credit

You are certainly familiar with credit cards, but you may not know about lines of credit. These, however, can prove to be helpful tools if used properly. Read on to learn the basics of lines of credit.

What Is a Line of Credit?

When you take out a line of credit from a bank or credit union, you receive the ability to borrow money as you need it up to a maximum amount for a particular period, the “draw period.” Some lenders provide a special card or checks for a line of credit. Others allow for direct transfer of borrowed funds to your checking. You pay no interest until you draw on the line of credit, and then you may pay money and interest back at any time before the due date. The money is available to borrow again as long as the draw period lasts. When the draw period ends, you will have an extended repayment period to pay back outstanding debt.

When Do You Use a Line of Credit?

Lines of credit come in handy when you must pay for a particular project yet need some flexibility to draw money. Many people rely on a line of credit for home improvements or education expenses because costs are spread out over some time. Having a line of credit allows you to draw funds as you need them and pay them back so they will be available for the next stage of the project or the next semester of tuition.

What Are the Benefits of a Line of Credit?

Lines of credit have the benefit of not accruing interest until you draw money in contrast to a regular loan in which you get the funds right away and start piling up interest right away, too. With a line of credit, you also have the option of borrowing only what you need when you need it. While you can do this with a credit card, too, interest rates tend to be lower with a line of credit.

What Are the Risks of a Line of Credit?

There are also risks to lines of credit. Some lines of credit are “secured,” which means that borrowers must put up collateral like their houses or savings accounts. This also means that non-payment can result in the loss of this collateral. Lines of credit that are “unsecured,” however, often carry higher interest rates. Finally, non-payment, late payment, or overuse of lines of credit can negatively affect your credit score.

Now you know the basics of lines of credit so you can decide if they are right for you.