What Are The Advantages and Disadvantages of Line of Credit - 4 Pillars Financial Wellness Advocate (2024)

FAQs

What are the advantages and disadvantages of a line of credit? ›

Lines of credit, like any financial product, have advantages and disadvantages, depending on how you use them. On one hand, excessive borrowing against a line of credit can get you into financial trouble. On the other hand, lines of credit can be cost-effective solutions to fund unexpected or major expenses.

Pros. You have access to the money when you need it. A line of credit loan allows you to access your equity as needed. You can use the money for anything you want, from an investment property to a holiday.

A credit facility often allows a company to have greater control over the amount and timing of debt, as well as the use of funds, than other types of lending agreements. However, a credit facility usually comes with debt covenants, additional maintenance fees, withdrawal fees, and is more difficult to secure.

A line of credit is a type of loan that lets you borrow money up to a pre-set limit. You don't need to use the funds for a specific purpose. You may use as little or as much of the funds as you like, up to a specified maximum. You may pay back the money you owe at any time.

Buying something on credit with some creditors (even when you can afford to pay cash for it) means you have a credit record. Using credit also has some disadvantages. Credit almost always costs money. You have to decide if the item is worth the extra expense of interest paid, the rate of interest and possible fees.

The pros of credit cards range from convenience and credit building to 0% financing, rewards and cheap currency conversion. The cons of credit cards include the potential to overspend easily, which leads to expensive debt if you don't pay in full, as well as credit score damage if you miss payments.

Personal loans are best for one-time, set expenses. Personal lines of credit are best for projects or purchases that require flexibility. Both options offer lower average rates than credit cards for borrowers with good credit. Repayment terms depend on how much you borrow and the length of your term.

The most obvious downside to a HELOC is that you need to use your home as collateral to secure your loan. In today's rising interest environment, the fact that HELOCs have variable interest rates is also less advantageous, as the Federal Reserve has indicated that it will need to keep interest rates higher for longer.

The process of paying back the line of credit is simple. You pay back part or all of the capital borrowed from your line of credit at your own pace. However, you must repay the minimum payment shown on your monthly statement.

What is the difference between a line of credit and a loan? ›

Loans are best for one-time, fixed expenses, like a house or car. Lines of credit, which are revolving credit lines, are better-suited for projects or purchases that need flexibility and may be used repeatedly for everyday purchases or emergencies.

Because you can usually get a line of credit at a lower interest rate than your credit card, using a line of credit to pay off credit card debt can reduce your total interest costs and reduce the amount of time you're in debt.

You can also pay bills or withdraw cash from your line of credit.

The minimum payment on most lines of credit is 2% of the balance or $50, whichever amount is greater.

You may not stand to lose your home or savings if you default on an unsecured line of credit. But the lender is taking on more risk with unsecured loans, which could lead to higher interest rates than with a secured line. Every unsecured line of credit has unique terms.

Both a credit card and a line of credit let you borrow money to a pre-set limit. And you may be charged interest depending on how quickly you repay what you borrow. A line of credit may offer a higher credit limit and lower interest rate. But credit cards earn rewards and can be used for in-person and online purchases.

Like credit cards, a line of credit is considered revolving debt and treated similarly when generating your credit score—if you make your payments in full and on time, it will reflect positively in your credit score. In this article, you will learn: How lines of credit work. If lines of credit affect your credit score.