Finances

What is a line of credit?

A line of credit can be a great way to finance a large purchase or help cover unexpected costs. Here's everything you need to know about lines of credit, including how they work and how to get one.

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Everything you need to know about lines of credit

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Learn what a line of credit is! Source: Adobe Stock

If you’ve ever been in the market for a loan, you may have come across the term “line of credit”. But what is a line of credit, exactly? And how does it work?

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This post will explain everything you need to know about lines of credit. So whether you’re considering applying for a line of credit or want to learn more about them, keep reading!

How does a line of credit work?

A line of credit, or LOC, is a borrowing option in which you’re approved upfront for a credit limit that you can draw on whenever you want. It is a loan that can be used like a credit card.

Lenders or credit unions offer it, and the borrowers can take the amount of money they need from the account up to a preset borrowing limit.

Interest rates will be charged, but only on the funds, you draw. Also, the interest rates are often variable and lower than in a one-time loan.

When applying for a line of credit, having a good credit history will improve your chances of being approved for the lowest rates.

Lenders usually set a draw period where you can borrow and repay money against your LOC.

After that, there is the repayment period, and you can no longer borrow against it and must repay the outstanding balance in fixed payments per month.

There are three common types of LOCs: personal, business, and home equity (HELOCs). And the condition of the repayment periods will be set in terms of the credit line agreement.

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Difference between a line of credit and a loan

There are some differences between a line of credit and a loan. Let’s begin with the basics!

While a LOC will allow you to have a revolving line and borrow money as needed, the loan will offer borrowers a lump sum.

Also, the annual percentage rate differs. For example, a LOC APR will range from 8.25% to 17.74%.

On the other hand, a loan APR might range from 4.99% to 35.99%, which is higher than credit lines.

In addition, in a LOC, borrowers will only pay interest on the outstanding balance. However, in a loan, interest is spread across all payments.

What credit score do you need to get a line of credit?

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Find out what credit score you need to get a line of credit! Source: Adobe Stock

Since your credit score shows lenders if you’re creditworthy and likely to pay a debt, it is recommended that you maintain a regular credit history.

Most lenders will require a good credit score, meaning you must have a FICO score of at least 670.

Furthermore, remember that having better credit rates will help you to qualify for a LOC easily. In addition, you’ll get to qualify for better terms and lower rates.

What can you use your line of credit for?

You can use it for a variety of purposes. It can be used for almost anything you want as long as it won’t put you in any financial trouble.

For example, people with irregular income can make good use of a LOC in case they don’t have enough funds for a monthly bill at a determined moment.

Also, it is a good resource for emergencies or for consolidating debt. Moreover, you can use a line of credit for home improvement, events, education costs, and business openings.

As previously said, it can be used for any purpose. And it can be worth it since it offers lower interest rates than loans and flexible repayment options.

Where can you get a line of credit?

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Everything you need to know about lines of credit. Source: Adobe Stock

As you just read above, LOCs can be great financial resources for achieving your financial goals.

As with any financial product, you must shop around before applying for a line of credit.

So you can do some research on lenders. Normally, LOCs are offered by financial institutions, such as credit unions and banks.

How to apply for a line of credit?

You can apply for a LOC through the lender’s website. In case you apply for a personal line of credit, you won’t need to make to offer collateral.

However, for home equity lines of credit, it is a requirement. Business LOCs offer both secured and unsecured options.

Also, lenders will request your personal and financial information and documents to prove your identity and that you have enough resources to pay back.

A credit check is also needed, so a hard inquiry is made before accepting any applicant, impacting your score.

Also, remember that keeping a good credit history will improve your chances of qualifying and getting better perks.  

Alternatives to lines of credit

If you think a line of credit isn’t the right product for you, you must remember that other credit products are on the market.

For example, depending on how much money you need, you can opt for a personal loan. There is also a variety of mortgage options available in the market.

In addition, applying for a credit card can be a good choice if you need the money for a large purchase.

If you want help choosing a good credit card, we have the right article. So read the post below and learn the best tips for selecting the best credit card for you!

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About the author  /  Beatriz Vieira

Beatriz Vieira is a producer and copywriter who is part of the finance writer team in this portal. She has a degree in Journalism and aims to improve her bilingual writing skills. Her subjects of most significant interest are culture, finances, and self-development.

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