Different Types of Lines of Credit
Have you ever wondered what a line of credit is? How does it work? What do I use it for? How many lines of credit should I have? If these are questions you’ve asked before, we’d like to help clear some of the air by breaking these questions down, going over the different types of lines of credit, and helping you recognize situations where one may help you.
A line of credit (LOC) is a form of revolving credit that allows a customer to draw funds up to the maximum loan amount determined by the financial institution – typically a bank or loan provider. The specific details of the loan, like the interest rates, the size of your payments, and your maximum withdrawal amount are generally determined by the lender. You can access these funds as long as you don’t go over your limit and meet all of the other necessary requirements, like making your minimum payments on time.
So, what would you need a line of credit for? Some of the general benefits are:
- Flexibility. This is one of its main benefits. You can request a particular amount up to your limit, but you don’t have to draw the entire amount. You can gear your use of the line of credit to your specific needs, and you’ll only need to pay interest on the amount you draw, not on the total amount you have available to you.
- Financial safety net. If you’re faced with an unexpected expense that you can’t cover with your savings, being able to draw on your line of credit can be a great way of handling this expense until your next paycheck.
- Flexible repayment. As long as you’re meeting your minimum payments, you can adjust how much you repay based on your budget. For example, you can pay off the entirety of your outstanding balance right away, or keep up with the minimum payments until you can pay the rest off. However, it’s always good to pay off as much as you can as soon as possible to avoid accruing more interest.
Types of Lines of Credit
There are a number of different lines of credit out there, each with there own nuances and uses. We’re going to take a look at loans like:
- Unsecured Lines of Credit
- Secured Lines of Credit
- Personal Lines of Credit
- Home Equity Lines of Credit
- Business Lines of Credit
Unsecured vs. Secured Lines of Credit
In a lot of cases, lines of credit are unsecured. What this means is that you won’t need to give the lender any collateral to secure your line of credit. But because of the increased risk for the lender, interest rates are higher than they are with a secured line of credit.
For example, a credit card is one of the most common versions of an unsecured line of credit, with your credit limit serving as the maximum amount you can borrow. You don’t offer any collateral when you’re opening a credit card account, so if you start to skimp on your payments, there aren’t any specific items the issuer of the card can take from you.
A secured line of credit requires you to offer up some sort of collateral – like your home or car – to secure the loan. If you don’t repay your debt, the lender can seize whatever asset you’ve offered up. This can be more appealing to lender because they have a way of securing payment in advance in the case that the borrower doesn’t pay their debt. But there’s also benefits to the borrower, as these loans will often have lower interest rates and a higher loan amount than unsecured LOCs.
Personal Line of Credit
The purpose of a personal line of credit is to give you access to unsecured funds that you can borrow and repay on a revolving basis. While there are certain general qualifications you need to be approved for these types of lines of credit, there are some important differences in this area based on the lender. For example, if you’re looking to secure a personal LOC from a bank, you typically need a credit score of 680 or higher. However, some online lenders like MoneyKey don’t weigh your credit score as heavily as traditional financial institutions like banks do.
To qualify for a line of credit with MoneyKey, you must:
- Be of legal age to contract in your state
- Be a US citizen or permanent resident
- Be a resident in the state where our product is offered
- Have an active bank account
- Have a regular source of income
- Have a valid contact number and an active email address
This line of credit is meant to be used when you’re facing an emergency expense that you can’t cover with your savings. For example, maybe your car breaks down and needs to go into the shop for some work, but you need your car for your commute to work. You’d need to get this dealt with right away or otherwise risk missing time at work.
Home Equity Line of Credit (HELOC)
With a home equity line of credit, you offer your house up as collateral, and your maximum borrowing limit is determined by the available equity in your house. It works similarly to other lines of credit in that you can borrow as much as you need up to your available limit – typically around 80 percent of what your home is valued at minus the balance owed on the mortgage – and continue to borrow funds as long as you repay your outstanding debt on time. When the draw period (which typically lasts 10 years) is over, the balance is due and the repayment period starts. There are usually closing costs that come with a HELOC, like the cost of having your property appraised.
HELOCS are typically used for bigger expenses or to consolidate high-interest debt. They generally have lower interest rates than other types of lines of credit and can be tax deductible. However, you can only deduct the interest paid on a HELOC if the money is being used to purchase, build, or substantially improve the home that is being used as collateral for the HELOC.
Business Line of Credit
A business line of credit is used by businesses to borrow money as they need it instead of taking out a separate, fixed loan. The lender will review the profitability of your business, the market value, and the risks taken on by the business, and use this information to determine the specific loan details.
Some of the benefits to business owners include:
- Speed. You won’t need to wait for approval from the lender every time you need to make a purchase.
- Flexibility. You can use it for nearly anything, like services, equipment, and inventory, as long as it’s a business expense.
Can I Have Multiple Lines of Credit?
You might be wondering how many lines of credit you can have, or if you can even have multiple lines of credit in the first place. The answer is that you can have multiple lines of credit at once, and there’s even a good chance that you’re likely to have several – like credit cards, your mortgage, student loans – throughout your life. The key is to make sure you’re keeping up with your payments on all of them in a timely manner.
Having multiple lines of credit can help build your credit score. When FICO – one of the most used credit scores you have access to – is calculating your score, they consider the variety of loans you’re managing. So if you’re handling different types of loans or credit, like credit cards and installment loans, FICO will see this as you having more experience with borrowing money. As long as you’re keeping up with your payments on time, keep a low credit utilization rate, and keep up with healthy credit practices, having multiple lines of credit might help improve your credit score.
While having more than one line of credit can be helpful in some ways, it doesn’t come without a few potential dangers. First off, accruing interest on a bunch of different loans will add to your monthly expenses and could potentially make it harder for you to meet all of your payment obligations. You may also increase the chances that you forget to pay a bill, which could hurt your credit score.
There’s also a chance that you could be slightly damaging your credit by taking out multiple loans, because it shows FICO that you might be in financial trouble.
How Many Lines of Credit Should I Have?
So, in the end, what is the ideal number of lines of credit to be juggling? Well, it’s not that simple. There’s no magic number that we can give you that’ll be just the perfect balance for you. It all depends on the requirements of the loan and your ability to comfortably pay them back.
While a new loan might give you the chance to raise your credit score, you shouldn’t be taking out new lines of credit unless you genuinely need them.
Educate Yourself on Lines of Credit
Navigating the ins and outs of lines of credit can be complicated, with so many different products and the nuances that come with each one. But they can also be incredibly helpful depending your specific financial needs.
If you need some extra cash on standby to have in the case of an emergency and don’t want to apply for a new loan when you need a little money, a personal line of credit might be a great option for you.
While you can have multiple lines of credit at the same time, it’s important to make sure you have the ability to make all your payments while still keeping up with your normal expenses. Otherwise, you risk damaging your credit and your financial situation in general.
If you’d like to learn more about lines of credit and about the application process for a MoneyKey Line of Credit, click here for more information!