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What is a line of credit?

What is a line of credit?

There are more ways to access credit than the standard personal loan with a set term. A line of credit may offer an alternative to borrowers looking to get cash without traditional restrictions.

Unlike a traditional loan which sees interest charged on the loan balance, your line of credit loan lender will only charge interest on the credit you have used. This makes a line of credit a competitive option for those looking to access funds for something like a renovation or family holiday without the added debt personal loan repayments can bring about.

What are the types of line of credit?

There are a few ways you can use a line of credit; as an alternative to a personal loan, an alternative to a car loan, or as a home equity loan.

Unsecured Line of Credit

A personal loan allows borrowers to access funds they need (usually between $5000 and $100,000) and repay them over a set period (usually up to 5 years). An unsecured line of credit, or overdraft, may be more attractive to those looking to avoid set repayment timeframes and costly interest charges. As a line of credit means you’ll only be charged interest on the amount of credit you access, as opposed to a full personal loan amount, this may be more economical in some financial circumstances.

Home Equity Loan

A secured line of credit loan, also called a home equity loan, is a flexible loan that acts similarly to a credit card. A home equity loan is a way to draw down on the equity in your home loan, and it’s typically used for personal loan purposes, such as paying for renovations, medical bills, urgent repairs, weddings, and holidays.

What is a Line of Credit Loan?

What can you use a line of credit for?

Much like a loan or a credit card, you can use a line of credit to access funds for a variety of personal reasons. The good news is that you don’t need to have this purpose approved by the lender before you apply.

Some Aussies may use a line of credit to pay for:

  • Buying a car
  • Home renovations
  • Holidays
  • Weddings
  • Funerals
  • Student fees and costs
  • Medical bills
  • Veterinary bills
  • Dental work
  • Legal cost

The limit is up to you. If you can prove to the lender that you meet the eligibility criteria, can service a line of credit responsibly, and are unlikely to miss repayments then you may be able to be approved for a line of credit

Some homeowners may use a home equity loan to access the equity in their mortgage to pay for home renovations and improvements. These improvements may then further increase the value of the house, boosting the level of equity in the home.

What alternatives to a line of credit are available?

The two main alternatives to a line of credit are a personal loan or a credit card. It may be worth assessing whether either option may be a better fit for your financial situation.

  • Personal loans – A personal loan may help borrowers in need of cash get access to funds to be repaid over a set period. It may be secured against an asset, potentially resulting in a lower interest, or unsecured. The main difference between this and an unsecured line of credit is the opportunity to secure the loan, as well as the notion of a loan term, which an unsecured line of credit will not have.
  • Credit cards - As a line of credit essentially acts as a credit card, only with lower average interest rates, it may be worth looking into low-rate credit cards or interest-free credit cards. These types of credit cards may allow you to pay for that big ticket item while avoiding high interest charges. Just keep in mind that if you opt for a card with an interest-free window, if you do not pay off the balance within the set timeframe you will be charged a revert interest rate.

Scenario: Jane wants to renovate her home

Jane has been living in her home for several years and has decided now is the time to renovate. She does not have all the funds available, so she’s considering her options for financing

Here are three potential ways she may be able to finance her home renovations, assuming her finances are in order, and she meets any eligibility criteria’s:

Financing optionChoice within financing optionHow interest is chargedWhat to keep in mind
Credit cardLow-rate credit card

0% interest purchase credit card

You may pay interest on what you spend.Low-rate credit cards will, on average, charge less interest on the amount you spend.

0% interest purchase credit cards will not charge you interest until the interest-free period is over.

Credit limits cap the amount you can spend. If you’re looking to spend a lot, keep the credit limit in mind.

Personal loanSecured personal loan

Unsecured personal loan

You pay interest on your entire loan amount.Secured loans require collateral and, in most cases, may have a lower rate than unsecured.
Line of creditHome equity loan

Unsecured line of credit

You pay interest on what you spend.Home equity loans let you down on equity in your property, with the property used as security.

Unsecured line of credit acts like a credit card but may be used for personal loan purposes.

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This article was reviewed by Personal Finance Editor Mark Bristow before it was published as part of RateCity's Fact Check process.

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Learn more about personal loans

What is a personal loan?

A personal loan sits somewhere between a home loan and a credit card loan. Unlike with a credit card, you need to sign a formal contract to access a personal loan. However, the process is easier and faster than taking out a mortgage.

Loan sizes typically range from several hundred dollars to tens of thousands of dollars, while loan terms usually run from one to five years. Personal loans are generally used to consolidate debts, pay emergency bills or fund one-off expenses like holidays.

Can I get a personal loan if I receive Centrelink payments?

It is hard, but not impossible, to qualify for a personal loan if you receive Centrelink payments.

Some lenders won’t lend money to people who are on welfare. However, other lenders will simply consider Centrelink payments as another factor to weigh up when they assess a person’s capacity to repay a loan. You should check with any prospective lender about their criteria before making a personal loan application.

How are personal loans regulated?

Personal lenders in Australia are regulated by ASIC (the Australian Securities & Investments Commission) and must follow responsible lending rules. That means they can’t lend money without making “reasonable inquiries” about a borrower’s financial situation and ensuring the loan is “not unsuitable” for them.

How long do personal loans take?

Depending on the lender, some personal loan applications can be approved in as little as one hour, or you may need to wait until the next business day. If approved, you may receive your money on the same day, the next business day, or within the week.

Where can I get a personal loan?

The Australian personal loans market contains dozens of lenders offering several hundred different products. Personal loans are available through a range of institutions, including:

There are three main ways to access personal loans. You can go through a comparison website, such as RateCity. You can use a finance broker. Or you can directly contact the lender.

What are the pros and cons of personal loans?

The advantages of personal loans are that they’re easier to obtain than mortgages and usually have lower interest rates than credit cards.

One disadvantage with personal loans is that you have to go through a formal application process, unlike when you borrow money on your credit card. Another disadvantage is that you’ll be charged a higher interest rate than if you borrowed the money as part of a mortgage.

Does refinancing a personal loan hurt your credit score?

Personal loan refinancing means taking out a new loan with more desirable terms in order to access a more competitive interest rate, longer loan term, better features, or even to consolidate debts.

In some situations, refinancing a personal loan can improve your credit score, while in others, it may have a negative impact. If you refinance multiple loans by consolidating these into one loan, it could improve your credit score as you’ll have only one outstanding debt liability. Your credit may also improve if you consistently pay the instalments on time.

However, applying to refinance with multiple lenders could negatively affect your credit if your applications are rejected. Also, if you delay or default the repayment, your credit score reduces.

Are there alternatives to $2000 loans?

If you need to borrow $2000 or less, alternatives to getting a personal loan or payday loan include using a credit card or the redraw facility of your home, car or personal loan.

Before you borrow $2000 on a credit card, remember that interest will continue being charged on what you owe until you clear your credit card balance. To minimise your interest, consider prioritising paying off your credit card.

Before you draw down $2000 in extra repayments from your home, car or personal loan using a redraw facility, note that fees and charges may apply, and drawing money from your loan may mean your loan will take longer to repay, costing you more in total interest.

What do credit scores have to do with personal loan interest rates?

There is a strong link between credit scores and personal loan interest rates because many lenders use credit scores to help decide what interest rates to offer to potential borrowers.

If you have a higher credit score, lenders will probably classify you as a lower-risk borrower. That means they’ll be keen to win your business, so they may offer you a lower interest rate if you apply for a personal loan.

If you have a lower credit score, lenders will probably classify you as a higher-risk borrower. That means they might be concerned about you defaulting on the loan and costing them money. As a result, they might protect themselves by charging you a higher interest rate.

What is a bad credit personal loan?

A bad credit personal loan is a personal loan designed for somebody with a bad credit history. This type of personal loan has higher interest rates than regular personal loans as well as higher fees.

What is a credit rating/score?

Your credit rating or credit score is a number that summarises how credit-worthy you are based on your credit history.

The lower your score, the more likely you are to be denied a loan or forced to pay a higher interest rate.

Can I get guaranteed approval for a bad credit personal loan?

Few, if any, lenders would be willing to give guaranteed approval for a bad credit personal loan. Borrowers with bad credit histories can have more complicated financial circumstances than other borrowers, so lenders will want time to study your application. 

It’s all about risk. When someone applies for a personal loan, the lender evaluates how likely that borrower would be to repay the money. Lenders are more willing to give personal loans to borrowers with good credit than bad credit because there’s a higher likelihood that the personal loan will be repaid. 

So a borrower with good credit is more likely to have a loan approved and to be approved faster, while a borrower with bad credit is less likely to have a loan approved and, if they are approved, may be approved slower.

Can students with no credit history get loans?

It is possible for students with no available history of borrowing or managing money to get a personal loan, though it may be more difficult as well as expensive than for borrowers with a good credit history.

Having no credit history means having no credit score. While many lenders may consider having no credit score to be better than having a bad credit score, they may still consider it riskier to lend to an unknown borrower and may charge higher interest rates or fees than to borrowers with good credit scores.

Is a personal loan a variable or fixed-rate loan?

Depending on the personal loan lender, you may be able to choose between a fixed and a variable interest rate. But, there are a few distinct differences between the two, so it’s important to weigh up the pros and cons before deciding on what’s right for you.

A fixed interest rate loan gets you the convenience of knowing exactly how much you need to repay each fortnight or month. On the other hand, you generally won’t be able to make lump sum or advanced payments to close your personal loan early - or at least not without a penalty.

With a variable interest rate personal loan, you may be able to get a longer loan repayment term, with the option of paying off the loan early. You typically won’t need to pay any additional charges for an early full repayment either. The potential disadvantage with an interest rate that can change is that your repayment is not entirely predictable, as it can fluctuate with the market. However, you’ll likely have more options as more lenders offer a variable interest rate personal loan.