During a financial emergency, most people don’t reach for a line of credit as their automatic go-to option. They usually choose quicker and often more expensive solutions like a payday loan, a fixed or variable-rate loan, a credit card, a GoFundMe campaign, or simply borrow money from friends or family.
Businesses use credit lines all the time to meet their capital needs or to take advantage of timely investment opportunities. These same lines of credit are also available to individuals if you know where to look. Banks don't usually advertise these lines of credit, so finding information about whether or not your financial institution even offers them may require some research.
How is a line of credit different than a loan?
A line of credit is actually a type of flexible loan that is taken out when people need to cover gaps in irregular income or finance a project where the total cost isn't known at the start.
Your bank or other financial institution will assess your needs and evaluate your credit rating. The bank will offer a defined amount of money that you can access as needed. You can choose to pay the money back right away or over time. Be aware though that like a payday loan, the interest on a line of credit is charged as soon as the money is borrowed.
How to get a line of credit
Calling your bank is usually the first step. Most financial institutions offer lines of credit even if they don’t advertise them. A borrower will have to be vetted and then approved by the bank before the line of credit is issued. All of the normal variables are checked including your credit score and your relationship to the bank. Even after you get approved, there are other things to consider.
How to use a line of credit
Lines of credit are mainly intended to be used for individuals to acquire items that might not be considered one-time purchases like houses or cars. Instead, they serve the same purpose as business lines of credit. Let’s say you are self-employed and there's a large delay between performing the work and getting paid. Instead of relying on credit cards, which can push you to the limit and mess with your credit score, you can take out a line of credit. The same lines of credit can be used for individuals who make quarterly tax payments and need a brief influx of cash in a timely manner.
How does line of credit interest work?
Interest rates on lines of credit vary, which makes it difficult to predict what the borrowed money will actually end up costing you in the end. Since there isn't any collateral involved, interest rates on lines of credit tend to be higher than interest rates on mortgages and car loans. The average rates range from 9 percent to 15 percent. The interest rate could be higher depending on the borrower's credit score.
Is the interest on a line of credit tax-deductible?
Home equity loans and lines of credit used to be tax-deductible, but they aren't anymore. The change has supplied a caveat for home equity loans when it comes to capital improvements on the property, but not on lines of credit. You can always double-check with your lender, but don't count on it.
Borrowers should be aware of any additional fees, unreasonable interest rates, and the terms of repayment before entering into any line of credit. Doing research is always the key to getting the best deal available. Don’t be afraid to ask questions either. It's important to avoid any complications that might arise due to misinterpretation.