Frequently Asked Questions About Lines of Credit
What is a line of credit?
A line of credit is a form of open-ended loan that works sort of like a credit card; a borrower applies for the line of credit, and if approved is able to borrow funds up to a certain pre-set limit. You only pay interest on what you actually borrow, and as you borrow it. You can pay back the balance owing at any time, in chunks or all at once – but you are required to make a minimum repayment each month, based on how much interest you owe. As with a credit card, once funds are repaid, the amount available to borrow resets. This makes a line of credit a form of revolving loan, which you can use as many times as you like, until it expires. Expiry is usually around 10 years after origination.
What are the types of lines of credit?
Lines of credit come in a few forms. Firstly, there are personal lines of credit and business lines of credit. Then there are secured lines of credit (which are backed by collateral of some kind, so in the event that you don’t pay back what you owe, the lender can claim that collateral as a form of payment), and unsecured lines of credit. There are also some more specific types: student lines of credit, designed for paying tuition fees and other costs associated with post-secondary education; and home equity lines of credit (HELOCs), a form of secured line of credit that uses your home as collateral. HELOCs in particular are very common in Canada.
How can I use a line of credit?
Lines of credit are useful because of their flexibility, and their structure means they are not really intended for single large purchases (such as a new car or house). Rather, they work best for intermittent cash flow needs, such as:
- Tuition fees
- Home improvement projects
- Running a small business or self-employment venture
- Emergency funds
While these are the most common uses for a line of credit, there are no restrictions on what you can use the funds for – once they’re in your bank account, you can spend as you like. Some people use them as a form of debt consolidation that is cheaper than a credit card.
Am I eligible for a line of credit?
To be determined eligible for a line of credit, the lender you choose will need to look at your financial information. This includes:
- Your credit score and credit history
- Your income levels
- The amount of other debts you have
- Information on your assets
All of this data taken together will inform a lender whether you are likely to be able to pay back the money you borrow. It will also help them to set the pre-approved limit on your line of credit, as well as the interest rate they’ll charge you. The better off you are, the higher your borrowing limit will be, and the lower your interest rate.
It’s also worth noting that secured lines of credit tend to be easier to get and have better rates than unsecured lines of credit – because they are backed by collateral and are less risky for the lender. So if you’re struggling to get approval for an unsecured line of credit, consider if you can try for a secured line instead.
What’s the interest rate on a line of credit?
Most lines of credit have variable rates that track slightly above Canada’s prime rate, and the amount over prime that you pay is called the “margin”. This margin is calculated on a borrower-by-borrower basis, and is set lower for low-risk borrowers, and higher for high-risk borrowers, to reflect the lender’s varying risk burden. In addition, interest rates on secured lines of credit are lower than on unsecured lines of credit. So for a HELOC, rates can start as low as 2%, and on unsecured personal lines of credit they start at about 4%. But these rates can rise to as high as 10%.
How much can I borrow with a line of credit?
The amount you can borrow with a line of credit depends on your circumstances, as well as whether it is secured or unsecured. Unsecured lines of credit top out at around $50,000 for the most qualified borrowers, while technically secured lines of credit can go much higher, depending on the value of the asset you use as collateral. For example, a HELOC can in theory offer borrowing room of as much as 80% of your home’s value.
How do I access a line of credit?
Accessing the funds you have been pre-approved for with a line of credit couldn’t be easier. You can write cheques based on these funds, use ATMs, or use telephone or online banking to pay bills directly or to transfer money into your chequing account.
Where can I get a line of credit?
Many financial institutions offer lines of credit; this includes banks and credit unions, as well as online lenders and alternative financial providers.
How much does a line of credit cost?
A line of credit is paid for in two ways: via the interest charges you incur through borrowing funds, and via fees. These fees come in a few forms. There are often application, loan origination, legal, administration or registration fees. These may or may not be charged by your chosen lender, and can be anything up to hundreds of dollars each. There are also usually fees if you fail to pay back money you have borrowed according to the line’s terms and conditions. Similar to a credit card, lines of credit require a minimum repayment amount each month, based on the balance owing. If you don’t make this minimum payment, you’ll be charged a penalty.