Wednesday, 19 December 2018

A line of credit is a remarkably flexible financial tool.

While it can be used for just about anything, a line of credit is ideal for people who are remodeling a home, planning for a big life event, starting a new business, or self-employed people who need a cashflow backup.

But as with any kind of credit, how you manage a line of credit is extremely important in order to maximize its benefits and avoid getting into unmanageable debt. So let's explore lines of credit, how they work, and how to best utilize them.

What is a line of credit?

Essentially a line of credit is a loan for a specified dollar amount, but instead of getting a check for the amount of the loan when you sign the paperwork, you access the funds when you need them up to the credit limit. You make monthly payments based on how much of your line you have used, or the outstanding balance. As you pay down your balance, funds up to your credit limit become available again.

Lines of credit are attractive for many reasons, including the financial flexibility they offer and they typically have lower interest rates than credit cards.

How do you qualify for a line of credit?

Obviously, as with any loan, a good credit score and reliable income are important to qualify.

Using your home as collateral — or an asset to secure the loan — can also help you qualify for a line of credit. When you use your home as collateral, the line is called a Home Equity Line of Credit and the amount of the line would be based on how much equity you have in your home. Lines secured by equity typically have lower interest rates than unsecured lines.

An unsecured line is more difficult to get, and the interest rate will more than likely be higher than with a secured line. But even at a slightly higher rate, an unsecured line of credit can be a very useful financial tool for many people and less expensive than a credit card.

Tips for managing a line of credit

Again, as with any credit, careful usage is the key to avoid getting into unnecessary and unaffordable debt. "A line of credit is good for someone with good financial discipline and who won't draw more than needed," Jennifer Williams, a BBVA Financial Planner says.

According to Williams, funds from a line of credit should ideally be used to build value and return on investment. For example, starting a business or remodeling your home.

"The funds can also be used to cover expenses and help with cash flow by a self-employed individual or someone starting a new business," Williams says. “They shouldn't be used to purchase items the owner cannot afford, such as a flat-screen TV."

When it comes to home remodeling, the National Association of Realtors' 2015 Home Remodeling Report ranked the projects most likely to return money for the dollar. They include a kitchen remodel, bathroom upgrades, adding a master suite, and new roofing and windows.

It's important to use your line for value-building purposes, Williams says, but it's also important to fully understand the specific line of credit you are getting, the terms and fees, and possible penalties for early repayment. It also pays to shop around and find the best deal and terms for your budget.

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