Many of us are familiar with the term line of credit but often don’t understand the difference in the type of lending that is being offered. I’ve worked within the investing and financial world for the last 5 years of my life and what I’ve come across with many consumers is they don’t fully understand what types of lending are available to them or even what type they have. One of the most common lending options misunderstood is the line of credit.
What is a line of credit?
A line of credit is a revolving debt treated similar to a credit card which you can usually find in the revolving section within your credit report. ![]
Many believe it is a bank loan because they are approved for a certain amount and can easily acquire the amount approved for in full, once offered, and withdraw cash if need be. It sounds like a loan, but it is not that.
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A line of credit has its pros and cons that make it a nice medium for a credit card and loan. Because the lender has offered you a certain amount, you could take the entire amount at one time if you needed to. You also have the option or flexibility to only withdraw or use the lesser amount of it if its unnecessary.
Example of Line of Credit:
You apply for a line of credit for $5000, you are approved and bank opens up a new trade-line. Now you are able to withdraw that money in one setting if you wish or use a portion of that.
That flexibility makes it different from an unsecured loan. In addition, once you have paid off the line of credit, even if you withdraw the full $5000 at one time, the line of credit just sits at zero until you use it again. Similar to a revolving credit card.
I’m sure you can now see why this isn’t a loan:
Don’t have to take out full amount
Dont have to reapply every time you need money.
Line of credit vs Credit card
Now to differentiate the line of credit from the credit card, the biggest difference is how the banks use these accounts. Most lines of credit used by banks and offered to consumers are overdraft protection accounts meaning they are automatically tethered to your personal checking account.(Most credit cards are not attached to an account). The other huge factor which separates them from credit cards, is how they accrue interest. Most credit cards accrue interest monthly,(meaning if you spend $2000 on credit cards, you have until the end of the month to pay things off before interest starts to accrue).
A line of credit accrues interest daily if you carry a balance. This encourages you to pay off the balance on the line of credit faster, but because of the daily interest the interest rate is often times lower than that of a credit card or loan. Before taking out any lending product, understand what the terms of those loans are.
I can’t tell you how many people would be in much less debt if they just had more knowledge.