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Wondering what a line of credit is and how it works? Here is everything that borrowers need to know about opening a personal line of credit.

What is a Line of Credit?

When people take out a line of credit, they come to an agreement with their institution in personal and business banking in York regarding how much money that they can borrow.

The lender will agree to lend out a certain amount, but a line of credit differs from other offerings like mortgage loans in York in that the borrower is free to withdraw money up to their credit limit as they please. In turn, the borrower will only pay interest on the money that they take out from the credit line.

For instance, if a borrower were to open a line of credit for $80,000 and take out $50,000 total, they would only have to pay interest on the $50,000 that they used. With other types of loan accounts in York, including mortgages in York, the borrower takes out the full amount right off the bat. They will then repay their loan accounts in York in full.

Anybody who qualifies for a line of credit will be able to take out money up to the credit limit at their leisure for a set time period before they enter the repayment period. If they repay funds while the credit line is still open, they are free to take out those funds again as they need.

The only thing that borrowers have to worry about is sticking with the terms of their line of credit. They will have to pay back any money they borrow according to the conditions laid out in the contract to enjoy continued access to their credit.

Why Take Out a Line of Credit?

One of the significant advantages that lines of credit offer over standard loan accounts in York is flexibility. Lenders are given access to money up to their credit limit as they need it and are free to either take it out or not take it out as they please.

The type of “on-demand” style financing can come in very handy for any type of expenses where a budget might be more difficult to predict, like home renovation projects, for example. Having an open line of credit can also help cover unexpected expenses like health costs or car repairs.

One of the great things about lines of credit is that there is no need to worry about having to pay interest until the money is actually taken out on the credit line. Even then, borrowers only pay interest on what they borrow, not the full amount of the line of credit itself.

By contrast, when people open up standard loan accounts in York, they will owe interest immediately on the full amount of the loan. They can still use the money as they want but they will have to pay it all back, not just the money that they borrow.

Because of this, lines of credit are often a preferred choice for people who are looking for more flexible borrowing options.

Personal Lines of Credit

There are two different types of lines of credit: lines of credits designed specifically for business banking in York and lines of credit for personal use. This article is going to focus on personal lines of credit.

Most personal lines of credit will be unsecured. There is often no need to have existing collateral to take one out. If a person is asked to open a secured line of credit, they will have to list some kind of collateral, usually a house or a car, in their contract.

The interest rates on a line of credit are usually at least partially determined according to a person’s credit score rating. People with a higher credit score are likely to be able to secure a more favorable interest rate than people with lower credit scores. People with bad credit might have difficulty getting a line of credit without a cosigner.

How Does a Line of Credit Work?

After qualifying for a line of credit, a borrower will have a set time period during which they will be able to borrow money from the account. This time frame is known as the “draw period.”  The draw period may last anywhere from several months to several years, depending on the contract terms.

Borrowers can withdraw money using online banking in York to transfer money from their line of credit into their personal checking or savings account. Once they do start borrowing, they can expect interest to accrue according to the total amount that they have borrowed. They might be expected to make minimum payments against what they borrow during the remainder of the draw period, but they will still have access to the money again once they pay it back.

The “repayment period” begins when the draw period ends. During the repayment period, the borrower will have a set amount of time to pay back the total amount that they borrowed during the draw payment. Sometimes a financial institution will set up automatic payment withdrawals to make it easy for borrowers to meet their payment schedule.

Will a Line of Credit Affect Credit Ratings?

It might, but the overall effect could be positive in the long term, as long as the borrower is able to pay back the money that they borrow on time.

However, the application process itself could have a slightly negative effect on credit scores. As is the process of applying for any type of credit, a bank or credit union will make a hard inquiry to find out more about the potential borrower’s credit history. The borrower will receive a slight ding on their credit score as a result.

People who only borrow a small amount of credit from their line of credit, or maybe don’t even use it at all, are likely to improve their credit score. In this case, the line of credit will improve their credit utilization rate, which is the ratio of available credit to money borrowed. In this way, opening a line of credit can actually be a good way for a person to improve their credit rating, as long as it is used responsibly.

The Takeaway

To make a long story short, opening a line of credit can be a great solution for anybody who wants flexible access to money when they need it without having to worry about paying interest on what they don’t borrow.

To learn about options for opening a line of credit or other available loan accounts in York, apply online, contact us at 717.767.5551 or email us at [email protected].