Lines of Credit Explained (What Is a Line of Credit and How Does it Work)

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Lines of Credit Explained (What Is a Line of Credit and How Does it Work)

In this video, I explained lines of credit with emphasis on these key areas:
1. What is a line of credit
2. Choosing the right line of credit for you.
3. Pros and cons of a line of credit, and finally
4. What you need to know before you borrow.

1. What is a line of credit
A line of credit is a type of loan that lets you borrow money up to a pre-set limit. You can pay back the money at any time, but you will have to pay interest on that money every month once you make any withdrawal. You only pay interest monthly on the amount you withdrew until you pay the balance back in full.

Usually, the interest rate on a line of credit is variable, meaning it may go up or down over time. Your credit score may also affect the interest you will pay on a line of credit, as it tells lenders how risky it is to lend you money, meaning the higher your credit score, the lower the interest rate on your line of credit.

For some lines of credit, you may have to pay a registration or administration fee. It is vital to ask your financial institution about any fees associated with a line of credit you borrow.
Each month, you will get a statement showing the amount you owe on your line of credit, and you must make a minimum payment every month.
This payment is equal to the monthly interest usually, but paying only the interest means that you'll never pay off the debt you owe.

2. Choose the right line of credit for you
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You can either apply for a secured or unsecured line of credit.
With a secured line of credit, you can use an asset as collateral for that line of credit. But if you don't pay back what you owe, the lender can take possession of that asset.

The advantage of a secured line of credit is that you can get a lower interest rate.
A home equity line of credit is a type of secured credit where your house acts as collateral, and it usually has a higher credit limit and lower interest rate than other loans and lines of credit.

But with an unsecured line of credit, the loan isn't secured by any of your assets. Examples are personal lines of credit and student lines of credit. A personal line of credit may be used for unexpected expenses or consolidating higher interest rate loans, while a student line of credit is specifically for paying for post-secondary education.

For a lender to determine your credit limit and interest rate, after you apply for a line of credit, they will ask for a lot of personal information. This is to confirm your identity and verify your finances to ensure you can repay your debt. They will consider your income, your current level of debt with other financial institutions, and your credit report; which is your record of paying your bills on time or paying back the money you borrowed.
Most financial institutions usually require a minimum household income of $35,000 to $50,000 to approve a line of credit.

3. Pros and cons of a line of credit
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Before you ever take on a line of credit loan, you must compare the pros and cons.
The main pros of a line of credit usually are:
(A) You will pay a lower interest rate compared to a credit card or a personal loan.
(B) Depending on the type of line of credit and financial institution, you may not be charged set-up fees or annual administration fees, and, if you bank with the same financial institution where you got your line of credit, you may be able to have an overdraft on your chequing account transferred to your line of credit.

While The Cons of a line of credit are:
(A)With easy access to money from a line of credit, you may get into serious financial trouble if you don't control your spending.
(B) If interest rates increase, you may have difficulty paying back your line of credit.

4. What you need to know before you borrow.
When you get a loan or line of credit with a federally regulated financial institution, you have the right to receive certain information.
Your lender may offer optional insurance for your line of credit, also known as balance protection insurance, balance insurance, or credit protection insurance.

It is vital to know that you don’t need to sign up for insurance to be approved on your line of credit, although this type of insurance may help cover a certain amount of your loan payments if you can’t make them due to illness, accident, death or if you lose your job.

I provide information on business, personal finance, life in Canada, and moving to Canada utilizing various sources.
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