Have you ever needed money but weren’t sure of the cheapest way to borrow it? Or missed a business opportunity because you didn’t have access to cash at the time? When people need funds, applying for a Line of Credit (LOC) is often not the first thing that comes to mind. Instead, they may think of borrowing from friends or family, using a credit card, applying for a traditional loan from the bank, or worse, turning to payday lenders. All of these are often considered before a Line of Credit.
Many businesses have long used Lines of Credit to meet working capital needs or seize strategic opportunities. However, LOCs are not as well known among individuals. This may be partly because banks don’t heavily advertise them, and potential borrowers don’t always think to ask. Yet, an LOC can be one of the cheapest and most suitable options for quickly obtaining funds—if you qualify.
A Line of Credit is typically offered by banks or financial institutions to creditworthy clients to address liquidity needs. Often referred to as a personal Line of Credit, it is generally more economical and has much lower interest rates compared to credit cards or other forms of credit.
Key Features of a Line of Credit:
- Credit Limit: You can borrow up to a specified limit and only pay interest on what you use. If you don’t use it, you won’t pay any interest. Having an LOC is like having a safety net—there when you need it, even if you don’t need it today. It’s often better to apply for a LOC when you don’t need the money because, during financial hardship (e.g., job loss), it may be harder to get approved, or you’ll face higher interest rates.
- Lower Interest Rates: LOCs generally have lower interest rates than credit cards. There are two types: secured and unsecured LOCs. A secured LOC requires collateral (e.g., real estate), while an unsecured one does not, but the interest rate for a secured LOC is usually lower. However, both are typically more affordable than credit card interest rates.
- Interest Calculations: Interest on a LOC is calculated daily on the amount withdrawn and for the number of days the money is used. For example, if you borrow $10,000 from an LOC with a 5% interest rate for 20 days, the total interest would be less than $28.
- Credit Score Benefits: An LOC can help improve your credit score if you maintain a good utilization ratio. For example, if you have a $20,000 LOC and a $2,000 credit card, using $2,000 monthly means you’re only using 10% of your total credit limit, which is positive for your credit score.
Credit Cards vs. Lines of Credit:
When you use a credit card, the total of your purchases accumulates, and you’re billed at the end of the month. If you pay off the entire balance by the due date, you won’t pay any interest—essentially getting a 21 to 51-day interest-free loan. However, if you don’t pay the full balance, interest will be charged on the unpaid portion at a high rate, typically around 20%.
On the other hand, LOC interest starts accruing immediately upon withdrawal, though at a lower rate than credit cards. Which option is better for you depends on how long you need the funds. For short-term borrowing, a credit card might be better (if you can pay it off by the due date). For longer-term borrowing, a LOC is usually more cost-effective.
Tip: The interest-free period (grace period) for credit cards only applies to purchases, not cash advances. If you withdraw cash from your credit card, you will be charged interest from the day of withdrawal, similar to a LOC.
