When it comes to getting a loan, many different options are available to consumers. One popular option is a line of credit. A line of credit offers a maximum limit that you may withdraw from. It’s known as a revolving loan because you can withdraw and repay as needed. The best part is that you don’t have to pay interest on any unused portion. Many Americans open a line of credit as a “just in case” account. For example, you can open a line of credit now that you can eventually draw from if you run into financial issues or need to cover an emergency medical expense. Aside from the luxury of flexibility, some additional benefits of a line of credit include:
- Ability to make withdrawals as needed
- Interest-only payments
- Building credit score
Opening a line of credit now is a good strategy if you need to use it down the road. However, not all lines of credit are created equal. This article will dive into different options to help you find the best line of credit.
Home Equity Line of Credit (HELOC)
A HELOC is an excellent option for homeowners. It has the lowest interest rate of all the line of credit options. This is because it’s secured by your home, which means your lender could foreclose on your home if you miss payments. Homeowners typically use HELOCs to finance renovations, consolidate high-interest debt, or as a down payment for a second home. To qualify for a HELOC, you will need sufficient home equity. Most lenders want you to have at least 15% to 20% home equity. For example, if your home is $1,000,000, you must not have debts attached to your home exceeding $800,000 to $850,000. Lenders will also compare your income with outstanding debt obligations to see if you can handle HELOC payments. If you meet eligibility requirements and are comfortable with the risk, a HELOC is your best option. Aside from having the lowest interest rates, they are offered by almost every lender.
Personal Line of Credit
A personal line of credit can be secured or unsecured. A secured line of credit always has a lower interest rate because they are safer for the lender. People typically use a personal line of credit to finance a large purchase, consolidate debt, or cover emergency expenses.
To qualify for a personal line of credit, you must have good to excellent credit. If your credit score is below 650, you will likely not qualify. In addition, lenders will look at your debt-to-income ratio and employment history. The higher your income and the lower your debts, the more likely you are to be approved for a personal line of credit. An unsecured personal line of credit is a good option if you don’t have collateral or prefer not to secure any assets. In contrast, a secured personal line of credit is great for non-homeowners who want a lower interest rate.
Credit Card
A credit card is a type of unsecured line of credit. Credit cards typically have high-interest rates and fees. Many people use credit cards for everyday purchases and emergencies. One of the main benefits of using a credit card is that you can often get rewards such as cashback or points that can be used for travel. Credit cards also have an interest-free grace period of 21 days. This means you have 21 days to pay back the loan otherwise, you will be charged interest.
You can qualify for a credit card with any credit score. However, If your credit score is below 650, you may need a secured credit card. Those with higher credit scores may qualify for exclusive credit cards with airport lounge access and travel rewards. In addition to your credit score, lenders will also look at your debt-to-income ratio and employment history. The higher your income and the lower your debts, the more likely you are to be approved for a credit card. A credit card is a good option to begin building a credit score. However, there are less expensive options available.
Secured vs. Unsecured Line of Credit
As mentioned frequently in this article, there are two line of credit categories. While a secured line of credit offers a lower interest rate, it comes with the risk of asset seizure. You receive a lower interest rate because your lender has collateral if you default on your loan. For example, frequently missing payments on your HELOC can result in home foreclosure. To receive a secured loan, you need an asset to collateralize. While this is usually a home, you can receive a secured loan on your car, insurance policy, or another asset.
An unsecured line of credit has a higher interest rate because the lender doesn’t have the same collateral. You could default on your loan without the risk of an asset seizure. However, this higher risk comes with a corresponding increase in interest rates. Unsecured lines of credit are also harder to qualify for because lenders want to ensure you can repay the loan.
Bottom Line
No matter what your financial needs are, there is a line of credit that can fit your situation. Lines of credit can be beneficial, but they also come with risks. Make sure you understand the terms of your loan and only borrow what you can afford to pay back. It’s essential to do your research to find the best option for you.
