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Most people aren’t in debt on purpose; more often than not debt happens when an unexpected expense or financial issue pops up. We cannot predict the future and people tend to ignore the fact that they need money to fall back on when they encounter difficulties in their lives. This is where a line of credit can help. Typically we suggest that you start an emergency fund to protect yourself from serious debt but in cases where this is not an option, a line of credit is the next best thing.

A line of credit

A line of credit is a temporary loan that is used to cover emergencies, short-term financial loss or pre-planned purchases or investments. This loan is usually available for people with good credit scores. To be eligible, you have to have a decent annual salary and a good credit rating. When you take out a line of credit you don’t pay any interest or annual fees unless you use it. Typically you pay 3% of your outstanding balance plus the interest. This temporary loan is a flexible way to borrow. You can use it to renovate your home or pay off higher interest debt. Some of the benefits of a line of credit are that it is convenient, interest is only charged on the amount you use and there is no need to re-apply; you can use it again even after paying off the credit you used and you choose how you repay the loan. The best thing about a line of credit is that if your account drops to below zero your bank covers it and charges you interest.

Secured vs. unsecured

There are two types of lines of credit, secured and unsecured. An unsecured line of credit is not backed up by any asset. The unsecured line of credit accumulates more interest that a secured one. A secured line of credit is backed by a valuable asset like your home or business. A secured line of credit has lower interest rates because it is secured against a valuable asset. Paying back the loan depends on the borrower’s circumstances and the asset that it is secured against.

Investing using your line of credit

Apart from paying back your debts, you can use a line of credit to make an investment; once your investment starts to flourish you can use your profits to pay off your line of credit completely. You can also take out a home equity line of credit and then use that money to reinvest in your home, for example you can use a home equity line of credit to fund home improvements that will increase the value of your home. A home equity line of credit is a great solution because once you start to see profits from your investment you can use them to pay off your line of credit.

Know your limits

It is very important to know when to use your line of credit and when not to use it. It is recommended that you only use it in case of emergencies. It is convenient to access it and pay it back but it’s a loan just like any other. It doesn’t make sense to use your line of credit for unnecessary purchases only to rake up more debt than you intended.

Another great reason to use your line of credit is to pay off other high interest debt you might have, like credit card debt. Typically your line of credit will have a lower interest rate than your credit card which means you’ll be able to save on interest in the long run. Always double check with your lenders and creditors to make sure paying off one type of debt with another is both allowed and a good option. It’s important that you know your limits and to not overspend your line of credit. It is easy to get into a debt spiral if you fall into the temptation of using your line of credit to buy expensive things you don’t need.

Lines of credit should be used for emergencies or pre-planned important purchases. They are a great financial tool that you can use to your advantage but it’s important that you spend them responsibly and make your payments on time. Misusing a line of credit will only create further financial difficulties and potentially put you into a lot of debt, the type of debt that you take years to pay back. Remember, a line of credit is just like any other type of loan and therefore should be used accordingly.

Caitlin Wood avatar on Loans Canada
Caitlin Wood

Caitlin Wood is the Editor-in-Chief at Loans Canada and specializes in personal finance. She is a graduate of Dawson College and Concordia University and has been working in the personal finance industry for over eight years. Caitlin has covered various subjects such as debt, credit, and loans. Her work has been published on Zoocasa, GoDaddy, and deBanked. She believes that education and knowledge are the two most important factors in the creation of healthy financial habits. She also believes that openly discussing money and credit, and the responsibilities that come with them can lead to better decisions and a greater sense of financial security.

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