What Is A Line Of Credit?

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What is a Line of Credit - Smarter Loans

A line of credit is a flexible loan for a predetermined amount. You use it more like a credit card and don’t start to pay payments or interest until you decide to use the credit available to you.

Once you tap into the funds, you pay monthly payments. You can use as much or as a little of the credit as you want, but the lender sets the minimum payment. Your payments may include principal and interest, or interest only. You can apply for a line of credit through banks, credit unions and online lenders listed here on Smarter Loans.

Lenders offer two types of lines of credit – secured and unsecured. A secured line of credit can save you money if you plan to use credit often (Toronto Star, 2012). It’s backed by collateral such as home equity or an investment, so it’s less risky for the lender. This means you normally get a lower interest rate and the lender may offer you a substantially higher loan limit.

Businesses have a strong track record of using them to meet working capital needs and also for strategic investment opportunities (Forbes, 2013). An individual can also use a secured personal line of credit for investments and to pay bills, but it offers additional benefits.

As a rule, most banks aren’t interested in underwriting one-time personal loans, and particularly not if you plan to borrow and repay, and then borrow again. They’d rather grant credit for steady, stable interest sources like mortgages. Credit cards work well for small, immediate expenses, but they carry high interest charges, making them impractical for large purchases.

Lines of credit have much lower interest rates than most credit cards. Credit cards may charge up to 28 per cent, while a line of credit offers a floating interest rate, usually a few percentage points above Canada’s prime.

Your line of credit also offers ease of use. You can withdraw cash from an ATM, transfer funds to other accounts and write cheques too. When you use it responsibly, it can facilitate investments, improve tax-efficiency and provide liquidity (Financial Post, 2013).

Equifax Canada shows Canadians continue to use credit more each year and many consumers realize a line of credit offers substantial advantages. One of these is access to funds for investments. You can borrow money and pay your minimum payments until you realize a gain on your investments. Since a line of credit offers competitive interest rates, wise investors can often build a strong portfolio and earn a profit. When you sell, you deduct the interest you paid to buy investments on your tax return.

Some people also borrow to make a large RRSP contribution to reduce or eliminate their taxes. They then repay the loan quickly and deduct the interest payments on their tax return.

Others pay down their mortgage and then use the equity to invest in a diversified portfolio to build their net worth. If they invest through an RRSP or a TFSA, they reduce their taxable income and can claim the interest paid to borrow on their tax return.

A line of credit is also an excellent way to protect against the financial implications of an unexpected event. You can maintain your cash flow and use your money to reduce taxes or to invest.

Senior executives may need to buy company shares as part of their employment. Instead of using their cash, they can use a line of credit. They can use their cash flow to contribute to an RRSP and lower their taxable income and their business expenses and interest charges to buy shares are tax deductible.

An unsecured line of credit rests on your credit history, your outstanding debts, and your ability to repay. Without collateral to back the credit, you will pay higher interest and lenders will often offer you a lower limit.

Countless lenders exist for a line of credit. Typically, credit limits range from around $5,000 upwards, but the internet has increased product availability so anything’s possible today. Some lenders and independent companies offer insurance on your line of credit too. For injury or death, they suspend payment and cover the balance.

A line of credit offers flexibility, ease of access, increased cash flow, and tax benefits when used wisely. It also offers lower interest rates than credit cards, making it the ideal vehicle for large purchases. Lending is a highly competitive business, so compare rates and terms to find a suitable product match.

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Smarter Loans is Canada's online loan directory for any type of financing. The website helps Canadians find reputable lenders & financial companies all over Canada and compare their products, rates, and terms in one place.

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