Lines of credit or open-ended loans are a good financial product for anyone who thinks they may need access to money in the future, but are not sure when or how much. This loan product is meant for emergencies or a series of small purchases, rather than one major purchase. There are a number of advantages to these loans, including flexibility, their ability to increase a borrower’s credit score, and their ability to adjust their interest rate.
Flexibility is the main reason that many borrowers cite when asked why they choose a line of credit. Unlike a conventional loan, a bank that gives someone a line of credit only states how much credit they have access to. There are very few restrictions placed on how much a borrower must take out and when. This allows a borrower to choose how much to borrow and when he or she wants to borrow it.
For example, a person with a $10,000 line of credit could choose to use any amount of this credit from nothing to $10,000. If he or she decided to take out $4000, then there would be $6000 remaining that he or she could withdraw at a later date.
This flexibility allows a borrower to take out only the money that they need. It also means that they will be able to control the amount they pay each month. By not taking out the fill amount of the line of credit, it is possible for a borrower to have a lower payment than they otherwise would have. Furthermore, as the borrower makes payments on the line of credit, he or she has the option to pay less each month or continue to make the same monthly payment but have a shorter payment period. Finally, the borrower can choose at any time to borrow against his or her line of credit again.
One of the rarely-discussed advantages to having a line of credit instead of a conventional loan is its ability to raise the borrower’s credit score. A large part of a person’s credit score is determined by looking at the ratio of how much credit has been extended to them versus how much they actually owe. A person who has had a lot of credit extended to them but has used very little of it will have a higher score than someone who has used nearly all of the credit they have been offered.
By applying and being approved for a line of credit, then using very little of it, a person can increase their credit score. While the exact amount of credit that can be used “safely” is considered a trade secret by the major credit bureaus, it is believed by many financial experts that anything less than twenty percent of the total credit line will not affect the credit score adversely.
Finally, some lines of credit allow a borrower to adjust and/or choose their interest rate. By applying for a line of credit with an adjustable interest rate, a borrower can qualify for credit immediately, then wait to borrow money until interest rates are low. This is ideal for people who plan to use a line of credit to finance an ongoing project, since they can choose when to take out money and when to wait out the market.