What happens when you need more than what you borrowed on a loan? You mistakenly thought that the amount was sufficient to meet the needs. However, it did not materialise that way. Instead, you need £3000 more to cover the requirement. Most personal loan providers offer the flexibility to redraw if the amount falls short.

What if it does not? Would you end up risking the deal or panicking? Here, a line of credit proves the biggest saviour. It helps you withdraw funds up to what you can afford, given your finances. For example, here, if you mistakenly borrow less, you can get £3000 more if you can afford to repay. This redraw facility proves a bane for individuals who often struggle to analyse the exact cash requirements.

What does a line of credit imply?

A line of credit is a revolving credit that allows you access to money up to the amount you can afford.  It works like this- you borrow a certain amount, you repay it, and borrow again for other needs. The creditor leverages the interest charges on the line of credit after the borrower takes the amount. Lenders set the amount of interest, payment size, and other issues. This cash facility is ideal to meet emergencies or short-term expenses.

It is flexible to use as borrowers don’t need to borrow up to the limit they can get. Instead, they can tailor their spending according to the use. In this, they pay interest only on the amount they borrow instead of the whole limit. Lastly, they can repay the outstanding balance every month. It helps them counter big-ticket purchases, emergencies, and other needs without worries.

What are some of the best examples of a Line of Credit?

The Lines of Credit can be secured and unsecured, depending on the needs of the person. You may consider unsecured ones to meet critical but short-term expenses like bill payments. Alternatively, secured lines of credit are ideal for long-term life goals like home renovation, buying a car, or a business property.  Here are some lines of credit examples that may help you understand the usage better:

1) Credit card

Everyone holds a credit card for big-ticket purchases, bill payments, loan payments, etc.  In this, you can use the credit up to the amount that your current finances allow. The credit card provider determines the limit by checking aspects like income, credit utilisation ratio, monthly expenses, debts, employment history, etc.

Accordingly, you get an amount within which you can conduct purchases. Afterwards, you clear the bill at the end of the month for the things you buy on credit. You should be careful while dealing with a credit card.

How to use a credit card responsibly?

One must compare the interest rates, APR, and other costs while getting a credit card. It helps you ensure that you get the most affordable one. Here is how to use one rightly:

• Understand the fees associated with a credit card as a revolving card facility
• Check the best ways to maximise rewards and discounts
• Keep your credit utilisation ratio to 30-40% (maximum)
• Know your expenses and create a budget
• Understand how much you can spend each month
• Set direct debits for the credit card payments.

2) Home Equity Line of Credit

It is a type of secured loan that you may consider for long-term life goals. It could be ideal for extending your home, using equity against monthly income, renovating, and renting. The Home Equity Line of Credit is usually backed by collateral, specifically the home. You may get up to 75-80% of the market value of the home. Here, you can subtract the balance you owe on the first mortgage cover (if any).

HELOC grants the flexibility to withdraw and repay the dues within 10 years. Meanwhile, the borrower can borrow, repay the dues, and borrow again for usage. It is also ideal for individuals who want to renovate and sell the property at a better rate.  However, HELOCs have closing fees that you must pay to get out of the loan agreement.

How to use a Home Equity Line of Credit responsibly?

To use it correctly, you must know the purposes for which you can use it. It is generally ideal for funding a heavy lump sum requirement. For example, you may use it to clear student loan debt, mortgage deposit or instalment, or a heavy medical debt. Here is what you must consider while using it:

• Check how interest rates may affect your monthly payments. The interest usually stays variable on a HELOC loan. It thus may increase or decrease the monthly instalment cost.
• Compare your options, loan fees, additional charges, etc. Look out for hidden fees which may impact the overall loan costs.
• Analyse the repayment terms. It is because you only pay interest during the withdrawal and the principal amount later.
• Always remember that you get the limit up to which you can borrow according to the property’s value. It is a secured loan that may lead to asset seizure if you cannot repay it in a timely manner.
• Access your ability to borrow and repay a particular amount by using a loan calculator. It will help you borrow only the amount you can fairly pay without worries.

Does an emergency fund operate just like credit cards?

No, an emergency fund does not operate like credit cards. It is not a line of credit facility. Unlike credit cards, you don’t get a credit limit up to which you can use the money. Instead, it is a savings strategy that helps you save a fixed amount every month for at least 6 months straight. It is strictly for the critical expenses and emergencies.

Moreover, unlike credit cards, there is a withdrawal and frequency limit. You cannot borrow beyond a particular amount and frequency. Otherwise, it may hamper the return on investment. An emergency fund is more about having access to cash, while a line of credit is about borrowing money in emergencies.

How to use emergency fund responsibly?

• Identify the difference between priority and unexpected expenses
• Avoid using the account for things like booking movie tickets
• Check funds regularly to ensure that they coincide well with your current needs
• If you use it up all, begin saving again
• Keep the emergency fund separate from the savings accounts

Bottom line

These are some types of line credit that you can consider. Identify the best version that you may use for your requirements. You can use HELOC for long-term and heavy credit requirements. Alternatively, a credit card is an option to pay the bills, purchase big-ticket items, and pay the dues later. Decide on one according to the requirement and the ability to repay the dues.