What You Need To Know About Line of Credit!
With the increase in variable expenses, you might at certain times find yourself in need of a lump sum of cash. While you will not require additional cash all year through, there are times when such a need pops up; for example, carrying out minor repair work around the house, exceeding your monthly expenditure before your next salary is due, or any other unexpected expenses.
A Line of Credit (LOC) helps solve these abrupt money requirements that arise unexpectedly at a given point of time. Unlike a car loan or traditional loan, the borrower takes from the line of credit when necessary, incurring interest charges only once they have withdrawn funds from the LOC.
Working of a LOC?
In a LOC, the lender pre-determines a specific amount up to which the borrower can spend, depending on his financial situation. This specific amount of money can be spent by the borrower at any point of time. The borrower need not take the entire lump sum like a traditional loan but can draw from it multiple times whenever needed, provided the borrower doesn’t exceed the amount determined by the lender.
In this way, the borrower has a certain amount made available to him, which he can access whenever required. The borrower pays an interest only on the money borrowed and not on the entire loan amount that he has access to.
Of course, the money borrowed carries an interest, but this interest is lower than that of credit cards and other types of loans.
Why a LOC?
A borrower can flexibly borrow money using a LOC. For example: the lender sets a predetermined amount of $7000 for the borrower. The borrower can make multiple withdrawals up to the limit of $7000. The borrower is therefore given the opportunity to access the $7000 as and when required. Once the borrower makes the first withdrawal, the interest payments will start. Once borrowed, the borrower can repay the money either in lump sum or in installments. So, if the borrower withdraws $3000 and repays it (monthly or in installments), they still have access to the remaining balance of the LOC.
A LOC acts as a revolving loan, accessible at any time to the borrower. Therefore, the main advantage of using a LOC is that it grants massive financial adaptability. A borrower avoids the hassle of taking a loan (like a mortgage), receiving the money upfront and then repaying the borrowed funds through monthly installments.
LOC are widely used by business owners and have become popular to solve individual cash requirements, too.
Secured and Unsecured LOC
A LOC can either be secured or unsecured. When a LOC is taken against home equity or any other collateral, it is considered to be a secured loan. A secured LOC proves to pose a lower risk to banks and therefore offer a lower interest on loan amount as compared to an unsecured LOC. When the LOC taken by the borrower is not backed by any collateral, it is unsecured and will carry a higher rate of interest. The payments for LOC could either be interest only payments or interest plus principal payments.