A line of credit is a loan that is given by a bank or credit union. A general line can be used for any purpose, whereas other types must be used in a specific way. Borrowers must qualify for the loan and make timely payments throughout the life of it. For those who use it responsibly, this type of loan can be a helpful tool.
Similar to a credit card, a line of credit must be applied for and approved by the lender. Those who have higher credit scores will have a better chance of receiving a loan than those who have no or low credit scores. This article will help applicants discern if this type of loan is appropriate as well as how to go about applying for one.
What is a line of credit?
There are a few key differences between a loan, a line and a credit card. Whenever someone applies for a loan, he or she is seeking a lump sum of money to use immediately but will repay over time, generally with set monthly payments.
Similarly, those with a credit card can charge up to their card limit and, then, repay it over time. However, how much to pay is mostly up to the card owner as long as he or she pays at least the minimum requirement. Those who pay it faster will spend less on interest.
If you are applying for a home equity line of credit, you are given access to a lump sum that you have access to whenever you need it. Until you actually use the money, however, no interest is owed.
The institution that loans you the money may give you a special card to use, or separate checks that give you direct access to this account. Sometimes they will instead transfer the money directly to your regular account once you request it.
Secured Versus Unsecured Line of Credit
Note that applicants can seek a credit line for personal or business reasons. Generally, personal lines do not require collateral. However, some lines will call for collateral, which means petitioners take a line of credit that is backed by an asset such as their home, car, savings account or bank account.
It is important for anyone who seeks credit to carefully study and review the terms of the payments. Each situation is unique, and terms may differ widely. It is also important to know if they have to pay an annual fee or draw fee to take out the money.
Tips for Qualifying for a Line of Credit
No matter what type of credit line you are applying for, there are a few simple steps you can take to ensure you are ready to take on a loan. Here are some helpful tips to consider when seeking a line of credit:
- Know your credit score. Your credit score is a massive factor in both your ability to qualify for a line and also in determining how much you are able to qualify for. Before you apply for a line of credit, take steps to ensure you know your score and have boosted it as much as possible.
- Research rates. Home equity line of credit rates can vary based on credit but are also based on where you apply, where you live and how much money you would like to borrow.
- Know what you want to use the line of credit on. While you can use the money on whatever you like with some loans, most institutions want to know what your plans are to spend thousands of dollars that belong to them. Have a plan and back it up with details.
Home Equity Line of Credit
One major reason people seek a credit line is for home improvements or renovations. For this type of credit, many people apply for a home equity line of credit (often called HELOC). This type of loan allows applicants to take a second mortgage from which they can draw out money.
To calculate how much a person might qualify for with a HELOC, lenders will appraise the home and see what the current market value is. Then, they will deduct the amount of money the homeowner owes on the home. Up to 85 percent of whatever the difference is becomes a potential loan amount.
Home Equity Line of Credit Vs Home Equity Loan
You have multiple options available when seeking financing for home projects. One major source of confusion is what the difference is between a home equity line of credit vs a home equity loan. The key differences include the interest rates. Home equity loans have a fixed rate while HELOC loans are often adjustable.
With a home equity loan, applicants will often get a lump sum all at once, but with a home equity line of credit, petitioners will be able to draw money as you need it. Because of the way the money is received, home equity loans have interest on the entire sum, while HELOC borrowers only pay interest on the amount they actually use.
Business Line of Credit
Another reason many people seek a loan is to expand their company with a business line of credit. This type of loan provides more flexibility than a regular business loan might, mainly because applicants only have to pay interest on whatever money they spend.
Those who qualify for a small business line of credit are given a certain limit, and they can withdraw, then repay, money as they please. As long as they don’t spend more than the credit limit, they can continually empty and refill this account.
To qualify for this type of loan, business owners need to show revenue statements and several years of history. This includes both personal and business tax returns, bank account statements and any other account documents you have available.
It’s important to note that many lenders will require collateral for a business or small business line of credit. This means that should you fail to repay your loan, the bank can seize assets such as your home, vehicles or other accounts. Just as with home equity loans, you should take special care to make sure you fully understand the terms of the loan before signing.