A line of credit (LOC) can be a valuable asset, giving you convenient access to money when you need it.
It’s a pretty simple idea: Once you’re approved for a LOC, you can borrow up to the maximum amount allowed. The interest rate only applies to the money you borrow — the same concept as a credit card. That means you can have more control over your finances and the cost of borrowing.
However, not all LOCs are the same. As with personal loans, credit cards, and many other financial products, the specific terms and conditions influence whether a line of credit will make financial sense for you. Your best bet is to find a line of credit that suits your needs, from the total amount available to the interest rate and repayment options.
Let’s take a closer look at what LOCs are. Then, we’ll review the pros and cons of accepting a line of credit if one is offered to you.
What is a line of credit?
A line of credit is a specific type of credit offered by financial institutions like banks and credit unions. If your application is approved, you’ll have the freedom to take out money up to the total credit limit.
You only make monthly payments (including principal and interest) on funds you use from your line of credit. That combination of flexibility and control can be very valuable.
As an individual, you’ll look for a personal line of credit. If you’re in search of funding for your company, you’d use a business line of credit.
In broad terms, LOCs and credit cards are very similar. There are two major differences to keep in mind, however.
The first is that credit cards can pay for something directly, in-person or online. With a line of credit, you’ll borrow money by moving funds into your chequing account (or with other methods, depending on the lender).
The second is that lines of credit can offer lower interest rates than credit cards. That’s not true for all lenders, which means you need to pay attention to the specifics of an offer.
Does accepting a line of credit affect credit scores?
Accepting and using a line of credit will affect your credit score. However, using your LOC responsibly can help to improve your score over time.
Lenders run hard credit checks when individuals accept a line of credit offered to them. This commonly leads to a drop in credit score. As long as you’re not requesting many types of credit or loans in a short period of time, though, the impact is generally very small.
Additionally, using your line of credit responsibly — making prompt payments, paying back what’s borrowed each month — can boost your score. Experian explains that a LOC can do the following when used correctly, all of which can boost your credit score:
- Reach the ideal credit utilization level of 30%
- Demonstrate your ability to make on-time payments
- Eventually helps you extend the length of your credit history
What is a pre-approved line of credit?
A pre-approved line of credit is an offer from a lender to accept an available line of credit. When you receive this kind of offer, it means the lender has already run a soft credit check and conditionally approved you. You’ll still need to go through a hard credit check to officially secure this LOC.
Should you accept a pre-approved line of credit? Consider the do’s and don’ts below to help you make your decision.
Do’s and Don'ts for Accepting a Line of Credit
Do accept a LOC if:
- You understand what LOCs are used for, how they’re paid for, and your repayment responsibilities.
- You’ve considered how a line of credit can affect your monthly budget and have a plan for making your payments. Be sure to consider the variable interest rate and the specific terms of the offer you received.
- You have a good reason to use revolving credit each month — a project with uncertain costs, a buffer for your household budget, or another need you’ve thought through.
Don’t accept a LOC if:
- You can’t realistically make payments on the amount you’ll borrow each month.
- You tend to be impulsive with money and would feel tempted to borrow more than you can afford to pay back.
- The terms and conditions offered by the lender aren’t in line with what you need to make your LOC useful for you.
At Innovation, it’s easy to find a line of credit that can work for you. Apply today!