Benefits of Opening a Line of Credit
July 31, 2020 by Daniel Azzoli
At one point or another, many people find themselves in need of some extra cash. Whether you’re planning ahead for a long-term project, or you need emergency funds for a steep hospital bill, a line of credit could be one solution to get you the money you need quickly.
When using a line of credit, you may avoid some of the pitfalls found in traditional installment loans. A line of credit offers a flexible way to borrow—and pay back—only as much money as you actually need.
Let’s explore the benefits of a line of credit, as well as some ways in which you might put yours to good use.
What Are Lines of Credit?
First, it’s important to understand what a line of credit is. Essentially, a line of credit is a predetermined spending limit that you can borrow from on demand, as frequently as you wish, as long as you have available funds.
In contrast to a traditional installment loan, where a bank or other financial institution will dole out a full cash payment that you must pay back through a fixed payment schedule, a line of credit can be thought of similarly to a credit card in some ways. You’re approved for a maximum spending limit, and you have the option to draw only what you need from that amount.
Another difference between using a line of credit versus a traditional loan is the interest structure. With a traditional loan, the full amount will begin accruing interest the minute that loan disperses into your bank account. So, if you’re approved for an $8,000 installment loan, you’d be paying interest on that full balance. But when using a line of credit, interest or other applicable charges are only assessed on the amount you actually draw, starting from the time you borrow it.
Does a Line of Credit Affect My Credit Score?
In short, it can, but not always. Like with most other traditional credit applications, after you request a line of credit, typically your lender will perform a hard inquiry on your credit history. This may result in a temporary dip in your credit scores, which may come back up once you’re approved and your line of credit is established.
It’s important to note, though, that not all lenders perform hard credit inquiries to approve your line of credit. Some may also look at a variety of other factors when considering your application for credit.
Regardless of credit inquiries, a line of credit may affect your credit score if the financial institution issuing the loan reports your payments (or non-payments) to a credit bureau. This is true of any kind of debt, so only apply for a line of credit if you’re confident you can afford your payments.
Another pro tip when using a line of credit: having a good credit score before you even apply can help you qualify for a better interest rate on your loan depending on the financial institution you’re applying with.
Benefits of a Line of Credit
No matter your circumstance, there may be some benefits of a line of credit for you to take advantage of. First, though, it’s important to note that there are different types of lines of credit, each of which may be helpful to you in different ways.
- A home equity line of credit (HELOC) is a secured line of credit, meaning it requires collateral—in this case, your house. Since you’re borrowing against the equity in your home, you can typically get a much higher balance on a home equity line of credit than most other credit types—perfect for major home renovations or expensive unexpected repairs. You may also deduct the interest paid on a HELOC if you use it primarily for home purchases or improvements.
- Business lines of credit are for just that—business expenses. The main benefit of a business line of credit is being able to pay for things as they arise, rather than having to wait around for lender approval and taking out separate loans each time you need extra cash. It’s a much faster and more efficient method for everyday expenses (and even some larger ones, too).
- Personal lines of credit are often the most flexible, and can be taken out for a variety of reasons. They are generally recommended for emergency use cases so you’re covered by a “rainy day” balance waiting for you when you need it unexpectedly. That, in turn, may give you some peace of mind—especially if you’re unsure whether your savings will cover sudden costs.
Other benefits of a line of credit include:
- It is a flexible way to meet your specific financial needs. You borrow only what you need from your available credit and pay back only what you borrow, plus interest and/or fees.
- It can be a huge help during unexpected emergency situations, for example, if you’re facing medical expenses or essential home repairs.
- It can help you consolidate many different debts into a single loan, often with a lower interest rate. You can use the line of credit to pay off various bills while only having to make payments based on the amount you draw. However, these are specific to debt consolidation loans, and are not recommended for every financial situation. Learn more here.
- Certain types of lines of credit may be a great option for long-term projects with unpredictable and variable costs.
Depending on the type of loan, a line of credit can be a fast and flexible way to access money as your circumstances demand it.
Using a Line of Credit
Once you’ve been approved for a line of credit, using it is similar to how you would use a credit card. Your lender might give you a special bank or access card, or a set of checks (common with home equity lines of credit) with which you can access your line of credit, or you may have to contact them to transfer money into your bank account when you need it.
Once you’ve used any or all of your available credit, interest will begin to accrue on the balance, along with any other applicable fees. In some cases, you may have the option to make a minimum payment, if you don’t pay off the balance in total, and if you make payments towards your principal (the amount you drew), it will go right back into your line of credit for you to borrow again.
If you think a line of credit is the right solution to help you cover an unexpected emergency expense, MoneyKey may be able to help. Contact us to hear more about our Line of Credit, or start your Line of Credit application today.