A line of credit is kind of like a credit card. You have a set amount you can borrow, and interest doesn’t begin until you start using the credit. And when you pay back the loan, your credit line is renewed.
For example, if you have a $20,000 line of credit and you use $5,000 on a home remodeling project, then your line of credit is now $15,000. You start paying interest when you borrow money from your line of credit. When you pay back the $5,000, your line of credit jumps back to $20,000.
But before you decide to open a line of credit, read on and learn the basics so you can get a feel for whether or not this is the best option for you.
Secured and Unsecured Lines of Credit
With a secured line of credit, you’re putting up collateral to secure the loan. If you buy a car with your line of credit, then your car is collateral. If you don’t repay the money you borrowed, you could lose your car.
A home equity line of credit is also a secured line of credit. The collateral is the equity in your house. The interest rates can be pretty good since it’s secured, but if you don’t pay it back as agreed, the lender can take your home.
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In contrast, a personal line of credit is unsecured, which means there’s no collateral. And since there’s no collateral, it’s riskier for the lender. So, the interest rates on an unsecured line of credit are a bit higher than they are on a secured line of credit.
How a Personal Line of Credit Works
People use personal credit lines for a variety of reasons, including funding remodeling projects, consolidating credit card debt and even paying for weddings.
If you want to apply for an unsecured personal line of credit, you first need to decide how much money you might need to complete your project or pay off your debt. You can then start researching your options.
Every institution will have its own rates and guidelines. For instance, Wells Fargo offers credit lines ranging from $3,000 to $100,000. Current interest rates range from 9.75 percent to 21.25 percent, and there’s a $25 annual fee. If you have an account with Wells Fargo, you qualify for a relationship discount.
But before you apply for a line of credit at any institution, you need to make sure your credit is in a very good place.
The Credit Requirements
Since a personal line of credit is unsecured, you’ll need good or great credit to get approved. So, before you apply, check your free annual credit reports and your credit score to see where you stand.
You’ll need a prime credit score to get the best rates. I’ve seen what’s considered a prime score fluctuate over the years, but right now a prime credit score is considered to be at least 720. A near prime score starts in the mid-to-high 600s, but if you’re in that category, it’s more difficult to get approved for a line of credit.
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Now, keep in mind that a line of credit is considered a revolving account, like your credit cards. If you use too much of your credit line or get sloppy with payments, it could decrease your credit score.
How to Apply
You can check with your bank to see if a line of credit is available. But even if it is, I recommend researching other options online and comparing rates. On many websites, you can get a preview of what your rate and payments might be. Also look for any fees that are involved. For instance, most credit lines come with an annual fee.
After you research your options and choose the bank or credit union, be prepared to provide some or all of the following information: your home address, employer information, your income, tax returns, bank statements and other pertinent financial information.
Response times are usually pretty quick, so if you’re approved, you won’t have to wait long for access to the funds.
What Not to Do With a Credit Line
One of the biggest advantages of a line of credit is getting funds quickly. And if you have great credit, you’ll get a good interest rate. Handle your line of credit responsibly and it could increase your credit score.
But the opposite can happen if you aren’t careful. I’ve seen people get in over their heads with a credit line when they used it for the wrong reasons.
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For example, don’t start thinking of this as your personal emergency fund. In fact, if you don’t have an emergency fund with at least six months’ worth of expenses, then postpone any home improvement projects on your list and get your rainy-day fund in good shape.
If you’re using a line of credit to pay off credit card debt, think about a balance transfer credit card first. A consumer with a prime credit score will most likely qualify for a zero percent annual percentage rate introductory offer on a balance transfer credit card. You can knock off your debt and pay zero interest during the intro period, which currently ranges from 12 to 21 months.
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What Is a Line of Credit? originally appeared on usnews.com
