Credit lines are like those relatives who neither fall into the favourite nor hate category. If you treat them well, then they can be super helpful but super damaging when you take one wrong step.
So before getting a credit line, understand how they work and find out its Pros & Cons!
What is a credit line:
In a line of credit, people or organisations can borrow money up to a certain limit, pay back what they borrowed, and then borrow again without applying for a loan. Every time a credit line is used, the borrowers have assessed a fee in addition to interest on the amount borrowed. Banks and trusted financial institutions are the best options for obtaining credit lines.
The most commonly used credit lines are personal lines of credit, business lines of credit and home equity lines of credit. How the interest rate and the credit limit of these credit lines are calculated depends upon the kind of credit line you avail.
Credit lines are of two categories:
- Secured credit lines
- Unsecured credit lines
In contrast to an unsecured loan, which does not require any collateral, secured loans require you to reserve your asset as security. The interest rates on an unsecured line of credit are higher since no collateral is needed. The lender has to bear the risk of you defaulting on your loan.
In a secured loan, the interest rates and fees will be reduced if your personal property is maintained as collateral since the lender can seize and take possession of your assets if you default on the loan.
The borrower is given a drawing term or a window of time during which money may be borrowed. After the draw time or you are required to make your full debt payment immediately or you may be given a payment window
How does a credit line work?
Here’s how a line of credit works: Let’s assume that you have a personal credit line of Rs 60,000 and that you spend Rs 10,000 from it. Then, rather than having to pay interest on the entire loan amount, you will just have to pay it on the Rs 10,000 you borrowed.
Your available credit will return to Rs 60,000 once you pay the principal sum plus interest.
Pros & Cons of a credit line:
- Interest charged only on the amount borrowed: Unlike loans, which have fixed EMIs whether or not the whole amount is used, when you use a credit line, you only have to pay interest on the amount you borrow rather than the entire loan.
- No Collateral: You can apply for a credit line and get approved instantly since it doesn’t require any collateral. With no collateral, procedures move quickly and with fewer verifications. Without putting up any of your assets as security, you can obtain the funds you need to deal with your financial requirements.
- Promotes Credit mix: If you have other loans such as car loans or credit cards, having a credit line can increase your credit score. Having a good credit score can help you negotiate the interest rate on your loans and make you a desirable candidate in the eyes of a lender.
- Consolidate high-interest debt: If you have credit card debt, auto loans, school loans, or other debt with interest rates greater than your credit line, you can utilise a personal line of credit to pay them off.
- High-interest rates: In the case of unsecured personal credit lines, the interest rates are higher than other available secured credit lines like HELOCs. That is to compensate for the risk of you defaulting on your loan.
- Promotes Impulse buying: Many people use their credit lines to splurge & wind up in debt they can’t afford. To avoid this fate, be mindful of where you’re using your credit line. You must stick to a budget and only use your credit line for necessary expenses.
- Ruins your credit score: If you make one late payment or default over one, that can impact your credit report and tank your credit score.
- Hidden fees: Personal credit lines come with additional fees like maintenance fees, origination fees and penalty fees for missed payments.