Money Minutes: Line of Credit
We know time is precious, and that you don’t want to waste too much of it attempting to wrap your head around financial know-how. Educating yourself about money, though, is crucial to cutting the stress and potential mess in dealing with your money matters. Our Money Minutes posts help you make sense of personal finance and money-related definitions, concepts, and advice that can be tricky and confusing to break down. We’ll help you make better sense of it in just a few short minutes! Today’s topic is:
A line of credit is an "arrangement between a financial institution . . . and a customer that establishes a maximum loan balance that the [financial institution] will permit the borrower to maintain. The borrower can draw down on the line of credit at any time, as long as he or she does not exceed the maximum set in the agreement." -Investopedia
What That Means for You
The nicest perk about line of credit, as opposed to a regular loan, is that interest is not charged on the amount of the line of credit not being used. So, if you take out a $10,000 line of credit but are only using $1,000 of it, you're only being charged interest on that $1,000. Conversely, if you take out a $10,000 loan, you'll be charged interest on that entire amount.
Where it gets a little iffy is when it comes to limiting yourself. Frequently, those who take out a line of credit dip into more and more of it, simply because it's there - even if they don't need to be spending the money.
There are two main types of lines of credit: personal and business.
Personal lines of credit are secured by the borrower's personal property (or collateral, such as a car or house) that the lending financial institution can seize should he or she be unable to pay. You've likely heard the term "HELOC" or "Home Equity Line of Credit" used before. This is the most common example of a long-term lending agreement.
Business lines of credit aren't all that different. Rather than using personal property as collateral, though, this line of credit is secured by your business's assetts - like company cars, furniture, and real estate.