What is a Line of Credit and How Does it Work?
A line of credit works similar to a credit card, it's unlimited access to a pool of money whenever you need it, sort of like your parent's wallet back in the day. Unlike your parent's wallet, with a line of credit, you have to pay the money back eventually - with interest. The great thing is, you only pay interest on the money use. Don't get too carried away though, this is not a "use it or lose it" kind of deal. I recommend only using what you need and making sure you have the money to pay it back.
A personal line of credit can be used for anything from paying your student loan bill to unexpected costs that come up like your cat's trip to the ER. Emergencies only! There are no limitations to what you can use the money for. Some people use them for home improvement projects (i.e. people who don't have student loan debt and can actually afford a house). If your idea of home improvement is decorating for Autumn with Chip & Jo's brand at Target, then you can use a LOC for something a little more practical like paying off your credit card.
Taking out a line of credit to pay off your credit card might seem like a dumb idea, but I promise it's not. LOCs have lower interest rates than credit cards. You'll need to keep in mind a few things to make this work to your advantage. You need good credit to take out a line of credit. You'll also need to make sure the limit on the LOC is higher than the balances on your credit card so you can pay off the total debt you owe. And you'll want to check the interest rate is several percentage points lower than your credit card's interest rate to make it worth your time and effort.
Now that we've covered what you can use a line of credit for, you might hear the terms "unsecured" and "secured" thrown around when talking LOCs. Personal LOCs are typically unsecured, which means that you don't need collateral like a house or a car to get one. All you need is a good credit score (700+), an ID, and some other personal info. A secured line of credit does require you put up the most valuable thing you own as collateral the bank can possess if you don't pay back what you owe. A secured LOC is more commonly used for business purposes or what's called a HELOC (Home Equity Line of Credit).
After you apply for a LOC, you'll be given a draw period, which is the amount of time you have to access the funds. The draw period can be up to several years. Once the time is up, you have the option to re-enlist so to speak. You can use your line of credit just by writing a check or electronic transfer. Remember to pay the balance monthly for what you use just like your credit card!
A personal line of credit can be a good option for you IF you can be responsible and use it as needed and not fund your next vacation. A LOC can be a lifeline for when your car breaks down, your dog needs dental work, or paying off that credit card balance quickly. Pay the monthly payment with interest and don't abuse it or you might lose it!