The average American carries $92,727 in debt. This means that most Americans are borrowing money in some form or another. Still, figuring out how to borrow money can be very stressful. If you don’t choose the right lending method, you may end up stuck in debt for the rest of your life.
When people need to borrow money, they often take out a line of credit. What is a line of credit? Read this financial terms guide to learn all about lines of credit.
What is a Line of Credit?
A line of credit allows you to borrow money when you need it, up to a preset borrowing limit. You’ll either need to repay your line of credit immediately or within a specific time period. As with other types of loans, a line of credit charges interest as soon as you borrow the money.
Borrowers also need to be approved for a line of credit by their bank. The interest rate for a line of credit is typically variable, which means you won’t know precisely how much the loan will end up costing you.
Typically, lines of credit are taken out for business or personal reasons, and you can also take out a home equity line of credit.
How Does a Line of Credit Work?
As mentioned, a line of credit works much like a credit card. It’s a type of revolving credit that lets you make card payments and write checks for any amount within your borrowing limit.
You can also make repayments in variable amounts, as long as you meet the monthly minimum requirement. You pay interest on the money you borrow, and as you pay down your balance, your available credit is replenished.
Lines of credit come with two main periods: the draw period and the repayment period. During the draw period, you can freely borrow money against your line of credit and repay it. During the repayment period, you’re no longer allowed to borrow money, and you must repay the outstanding balance. Typically, this is done in fixed monthly payments.
Unsecured vs. Secured Line of Credit
A line of credit may be secured or unsecured. If it’s secured, that means you’ll need to put up a personal asset as collateral. This may be your home, car, or some other valuable possession.
With an unsecured line of credit, a lender will assess our finances and credit history to determine how likely you are to repay a loan. Unsecured credit doesn’t involve any collateral, making it riskier for lenders. For this reason, unsecured loans tend to come with higher interest rates.
While most personal lines of credit are unsecured, there are two popular types of secured lines of credit. These include home equity lines of credit and lines of credit secured by certificates of deposit.
Financial Terms: Is a Line of Credit Right for You?
Now that you’ve read this financial terms guide, it’s time to decide if a line of credit is right for you. If the answer is yes, then you need to speak to your bank about taking out a line of credit.
And, check back in with our blog for more financial tips.