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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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