At one time or the other, we all need money for various reasons. While some people need money to sort out emergencies, other people might want extra cash to meet essential needs, such as home renovations.
Often, the first point of call for many Canadians is to get a traditional loan. Although a personal loan is a good idea to get more funds for your financial needs, it’s not the only way.
One of the available and suitable loan options is a Line of Credit with flexible and affordable interests. Despite its popularity among Canadians, the line of credit is not well understood. This piece will delve into the nitty-gritty of a line of credit, including the types, rates, benefits, and how it works? But first,
What is a Line of Credit?
A line of credit (LOC) is a flexible and revolving loan type that gives you continuous access to funds up to the preset limit. You can borrow money for any purpose you choose, repay at any time and borrow all over again, as long as you’re within the specified maximum limit. Interestingly, you’ll only pay interest on the funds you use or borrow.
How Line Of Credit Works in Canada
Unlike a traditional or personal loan, where the entire loan amount is given out as a lump sum to be paid back at a predetermined period, a Line of Credit gives you convenient access to cash with reusable available credit. The lender usually sets a limit of a specific balance that you can withdraw for your financial needs.
You’re at liberty to borrow little or as much as you want from the available funds, provided you’re within the set credit limit. Also, you can use the money for any purpose or specific needs. Unlike a traditional loan, once you apply and get approved for a line of credit, you don’t have to reapply to access more funds.
If you take a Line of Credit, you won’t pay any interest or fees until you use any part of the available funds. However, you’re expected to pay interest on any amount you borrow.
The monthly interest accumulates from the first day you took the funds to the last day of repayment. When you take out a loan from your available Line of Credit, you can set up a repayment plan to reduce your debts and have more credits to borrow whenever you need the funds.
Where Can I Get a Line Of Credit?
Usually, lenders offered a line of credit that generally determines the credit limit of the borrower. Banks, Credit Unions, and other financial institutions in Canada provide a Line of Credit to borrowers.
The issuing bank, credit union, or online lender will determine your credit limit and interest rate based on your personal information and financial information, such as your income and credit report. To get a line of credit, you can apply with any of the traditional banks, preferably with the bank that you have an account with.
How Is Interest Paid On a Line Of Credit?
Generally, the interest rate charged by lenders on a line of credit is variable – it changes from time to time and is determined by the provider.
Eventually, you can have a high-interest rate in the first quarter of a particular year and be charged a lower rate by the third quarter of that year. However, a line of credit usually has a lower interest rate than other debt financing or loans such as credit cards.
You should note that interest is charged only on the amount you borrow or withdraw from your available credit limit. For instance, if you have a $10,000 line of credit and choose to withdraw $2000 for any purpose, you’ll only pay interest on the withdrawn $2000 and not on the entire $10,000.
How Can I Get Money from a Line Of Credit?
Once you’re approved for a line of credit by your lender or financial service provider, the lender will notify you of your available credit limit. You can access the funds and withdraw any amount from the available credit through:
- Automated Teller Machine (ATM).
- Writing of cheques drawn on your line of credit.
- Online or telephone banking for bank transfer or bill payments.
Reasons for Getting a Line Of Credit
Here are some general and specific needs why people might consider a line of credit:
- To finance a home renovation or repairs.
- To sponsor a portion of your home purchase (home equity line of credit).
- To finance a big purchase, such as buying a vehicle.
- To have the financial flexibility and have enough funds for emergency financial situations.
- For debt consolidation, primarily high-interest debts.
- For investment.
Categories of Line Of Credit
Line of credits can be grouped into two basic categories – Secured LOC and Unsecured LOC.
1. Secured Line of Credit
A secured line of credit is backed by an asset that serves as collateral for the money you borrow from the lender. You can get a Secured line of credit using your home, car, investment portfolio, or any high-value asset as collateral against the loan.
This is an assurance to the lender that even if you default in repayment, they can take possession of the asset to recover the loan. Though interest rate in a secured line of credit is variable, borrowers usually enjoy a lower interest rate than an Unsecured line of credit. A typical example of a Secured line of credit is:
Home Equity Line of Credit (HELOC)
HELOC is a famous secured line of credit whereby you use your home as collateral against the loan. As a result, you’re expected to own the house with at least 15 to 20 percent equity. The home is usually a valuable asset with high investment value; hence, HELOC typically has a higher credit limit and lower interest rates than other types of line of credit.
2. Unsecured Line of Credit
Any asset or collateral does not back an unsecured line of credit. Therefore, lenders consider many factors (such as your credit report and financial standing) in determining the credit limit and approval. Also, lenders usually require a household income of at least $35,000 to $50,000 before approval.
As a result, many borrowers find it hard to qualify for an unsecured line of credit. The variable interest rate is usually higher than a secured LOC but lower than credit cards or personal loans. Examples of Unsecured line of credit include:
Personal Line Of Credit
A personal line of credit is suitable for debt consolidation and other emergency expenses. It is the most popular among Canadians, as it holds no risk to the borrower. Interest rates are usually high but lower than credit card and traditional personal loans.
Student Line Of Credit
A student line of credit is an unsecured LOC designed for part-time or full-time students of recognized post-secondary educational institutions. You can use the student LOC to offset educational and essential expenses, such as tuition, books, housing, transportation, food, etc. When you take a student line of credit, you can start the repayment while still studying or after graduation.
Applying For a Line Of Credit in Canada
When applying for a line of credit in Canada, lenders require your personal information, financial records, and documents that prove that you’re not a credit risk to the lender.
Banks and credit unions typically require additional information that other lenders might overlook, depending on the Line of Credit category you’re applying.
Some of the necessary information needed includes:
- Your personal information.
- A good credit score of about 650 and above.
- Your income information.
- Your payment history.
- Programme of study for student LOC.
- Household income of about $35,000 to $50,000.
How Can I Get a Good Line Of Credit Rate?
The line of credit interest rate is determined by the issuer, depending on the borrower’s type and financial standing. The interest rate is variable, and it can go up or down. To get a reasonable LOC rate, here are few tips to help you:
- Endure that you have good credit ratings. A bad credit report or non-payment of debts will portray you as a credit risk and may lead to denial or a slim credit limit.
- Shop around and compare the line of credit interest rates from different financial institutions.
- You can switch banks to get a better internet rate package and enjoy the benefits of new customers. You have to be cautious about this. Check our guide on how to switch banks in Canada.
Tips on How to Maximize Your Line Of Credit
- Remember that the loan must be repaid with interests. Failure to do so will damage your credit score.
- Plan ahead on the purpose of the loan. Regardless of your available credit limit, try to pay past debts before taking another to avoid piling up debts.
- When paying the LOC’s interests, ensure to pay down your debts to avoid plunging into a financial mess due to the inability to pay your debts.
- Pay your secured line of credit loans in time to avoid losing your collateral/asset.
- Do not exceed your credit limit.
- If you have high-interest debts, consolidate the debts with a line of credit.
- Line of credit usually has a lower interest rate than credit cards or traditional loans.
- LOC usually comes with no annual administrative fees.
- You only pay interest on the amount you borrow, not on the entire available credit.
- There’s no reapplication needed. Once you apply and get approved, you can borrow, repay, and borrow again within the specified credit limit.
- LOC offers flexible usage of funds such that you can withdraw only the amount you need per time and use it for any purpose.
- As you only pay interest on borrowed funds, it can lead to the piling up of debts.
- There’s no repayment set time, which can lead to more deficits.
- The variable interest rate could rise, making it difficult to pay back the loan.
- Your credit score can be damaged if you miss LOC payments.
- You could lose your assets if you’re unable to pay your secured LOC.
A line of credit is a loan type that should be used for the specific purpose of taking the loan. Always borrow what you can afford to pay back to avoid finding yourself in a debt situation.
It would be best if you talked to your financial advisor for guidance on how a line of credit can help your finances and other available loan options, such as car title loans, business loans, etc.