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What Is a Line of Credit?

If you need extra financing and want to avoid a traditional bank loan, a line of credit might be the answer. Learn everything you need to know about getting a line of credit, right here.

Line of credit loan vs. traditional loan

A line of credit differs from a traditional loan due to the lack of fixed term. With a traditional loan, you receive your agreed amount and must pay it back in installations at set times. If you opt for a business line of credit instead, you can have access to funding at any time.  It’s like a credit card in the sense that credit is always open to you, within your set credit limit, provided you pay it back in time. That means you don’t have to go through stressful loan applications every time you need extra financing, you can simply borrow with your line of credit and pay it back much like a credit card. This makes a line of credit loan a much more flexible option.

Are line of credit interest rates higher than bank loans?

Generally speaking, line of credit loans will operate with variable rate interest. This can mean that line of credit interest rates are higher than interest rates for a personal bank loan, which often comes with a fixed interest rate. If you need to know precisely what you’ll be paying back each month to manage your own budgeting, then you may be better off with a traditional loan with fixed rate interest than a line of credit.

Do you pay line of credit interest rates on your whole credit limit?

No, you only pay interest on what you have used of the credit available to you. So, if you have a line of credit limit of $50,000 but you’ve only used $10,000, you’ll only need to pay interest on the $10,000.

Why should I use a line of credit?

As we mentioned, a line of credit is more flexible than a bank loan and for many people this makes it a handy safety net. Once your line of credit is open, you can use it as and when you need it, making it a good option for businesses with a healthy cash flow that are able to pay it back comfortably. A line of credit loan is also very useful for investors, who need funds readily available when exciting investing opportunities come up (since these types of opportunities may not stick around for the time needed to get a bank loan).

However, for some people, this same flexibility may only be a slippery slope, encouraging more borrowing than necessary and leading to debt. A traditional bank loan will require you to determine the amount you need, and this extra time taken to consider your budget may make all the difference to your attitude to loan repayment.

Business line of credit pros and cons

Make sure to weigh out the disadvantages and advantages of a business line of credit before you take the plunge. While flexibility is a good thing, the structure of a traditional loan may be better suited to your needs. Here’s a little more information about the pros and cons of a line of credit:

Business line of credit pros

  • Flexible, so you can get funds as and when you need them

  • Easier repayments, as there are usually more options for repayments than with traditional loans

Cons of business line of credit loans:

  • Higher interest rates

  • Some payment options (like interest-only repayments) can cost more in the long term

  • Lenders may have stricter criteria for these loans

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