Thursday, February 9, 2017

Line of Credit – The Upside and Downside

Have you ever tried something only to discover later that it wasn’t suitable for you? Imagine a relaxing game of golf, a sweater fashioned in trendy colours, or mouthwatering, savory lobster. You may not feel the same about certain activities or things as your friend.   There is truth in Paul Alessi’s words. “There are two sides to every story.”

Depending on the story, situation, or product, you are likely to lean heavily one way or the other. You either like it or you don’t.  You prefer the upside and don’t see any downside. If you are optimistic, you see only the bright side and avoid the dark side.   

Such is the case with the various loan products on the market.  Loans have two stories, advantages and disadvantages. Different loan products are created specifically for different needs.  The features and benefits of a Line of Credit (otherwise known as a revolving loan) are designed to accommodate unique circumstances.  



A “Line of Credit” is different from your traditional loan in such a way that you can access “borrowed cash” at any time for any purpose.  Like a credit card, a specific limit is assigned with a Line of Credit, allowing you to draw down to the limit.

These loan products are becoming incredibly popular. Having a Line of Credit is convenient for you and your loan officer.  Instead of running to the bank every time you need a loan, you make an application only once for a Line of Credit.

One major benefit is the interest is calculated daily only on the outstanding balance. You are only charged interest on the amount of money used. If you dip into your Line of Credit two days prior to payday, then interest is charged only for those days. Generally, the interest rate with a Line of Credit is lower than any credit card, saving you money on interest charges.   

Another benefit most people appreciate is that, unlike a credit card, you are not required to make specific payments monthly.  The monthly interest charges are billed against your available balance. However, the expectation is that deposits are made regularly to ensure the account revolves and is used appropriately.   

This pool of readily available cash can be accessed for any purpose at any time. When emergencies occur, you may suddenly find yourself in a pinch. It’s an acceptable practice to use someone else’s cash to pull you through a rough spot.  The question to ask yourself is whether you can become too dependent on a Line of Credit.  Even with a lower interest rate, the interest costs on a Line of Credit add up to a significant amount over an extended period of time. You may discover you are regularly touching the bottom on your limit.

Bank Statement - Line of Credit



Lines of Credit can certainly be a security blanket when your emergency savings are inadequate to cover your present situation.  

The upside obviously spoke about convenience. We live in a world where “instant results” have become an expectation. Having access to credit for expenses or purchases is a privilege.  We shouldn’t take advantage of credit for every desire because one day we may find ourselves in financial trouble when we have overextended the boundaries.  The blog, Choosing Your Debt Wisely, proves how debt can quickly become out of control.      

As previously mentioned, one attraction of a Line of Credit (LOC) is the interest rate. Compared to a credit card or payday loan, the Line of Credit interest rate is lower than these two.  Take another step and secure your Line of Credit with property. The interest rate is reduced further simply because your promise to pay back the money is pledged by an asset, something you own.  The security can either be your home, vehicle, or investments.  You declare, “I solemnly swear to pay back every penny, and if I don’t, you may take my house, car, boat, and my children.” (I’m kidding about the children.)  Don’t overlook the risk you are taking when you pledge security.

The downside to becoming too dependent on Lines of Credit is that we never see the light, the bright side of being debt free forever.  Lines of Credit are loans.  Borrowed money eventually has to be paid back. As long as we are working and have the means to pay back borrowed money, everything rolls along until the income stops.  Job layoffs, sudden illnesses, and disabilities can interrupt a steady income. The inability to pay back the Line of Credit can suddenly mean financial devastation. 

Be wary of the convenience and low interest rate that a Line of Credit claims to offer.  It’s true that interest is calculated daily only on the amount you use; however, the financial damage occurs when you compromise security for convenience.  This loan product disguises borrowing money for purchases with a convincing argument that a Line of Credit saves you money.   Home equity loans allow the equity in your home to be used for other purposes: debt consolidation, home renovations, investment opportunities, and vehicle purchases.   The intent with this type of loan product is to simplify your life by combining your income and debt under one roof (one account).  You may be convinced the true intent is to lower your borrowing costs.  That’s a good point but you must know and trust yourself. Although this loan product and strategy may work for someone, it’s not necessarily the right product for everyone. Your responsibility is to fully understand the product and match the right one to your needs.



Remember we know our spending habits.  Sometimes, we have a tendency to believe that if we have money available on our Line of Credit, we have cash but these are two different animals. Credit is not cash.

When I had a Line of Credit attached to my chequing account, I constantly did the math.  I calculated how much I could spend before I hit the limit.  That kind of wrong thinking left me frustrated. I finally recognized the craziness in my logic.  If my account was into my $1,000 Line of Credit by $956.55, I believed I had $43.45 in my account.  Seriously? I was in debt $956.55.  Nothing could change the math. For me, the worst part was seeing a negative balance all the time.  I always felt broke.   Then, I opted to replace my Line of Credit with a revolving loan product separate from my chequing account.  I preferred regular payments which ensured my loan would be eventually paid.  The best part was seeing the positive balance in my chequing account, even if it was only $1.

If you are disciplined, then you have no worries.  If you’re not disciplined and are madly in love with the Line of Credit product, I often recommended attaching the credit limit to a separate account, apart from your active chequing account.  Then you can apply consistent payments to the outstanding loan balance with the intention of eventually paying off the debt.

The secret is in knowing whether you can trust yourself with the freedom to have an endless amount of credit (not cash).  Your responsibility is to learn and understand the different loan products. With the right advice, you can match the right one to your needs.  Managing your debt responsibly is one sure way to live a worry-free lifestyle.

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