It may be your year to renovate the basement or take a trip of a lifetime – even if your travel savings account isn’t quite where it needs to be.
Or maybe you need cash for some big, unexpected and expensive thing like a leaky roof. If so, then a personal line of credit may be just the ticket. But be warned: they come with their own pitfalls, not the least of which is temptation
Here are 10 things you need to know about a line of credit:
1. What is it?
A personal line of credit is a predetermined loan that allows you to spend up to a certain amount. Unlike a regular loan, you don’t start paying interest charges until you decide to use it. You can use as much of the line of credit as you want, and pay back any amount as long as you make the minimum monthly payments set by your lender. Minimum payments may be a combination of interest and principal or interest only.
2. Who offers them?
PLCs are offered through banks and credit unions. Often you can apply online.
3. You may already have one – sort of
Most banks offer overdraft protection on your chequing or savings accounts, which is in effect an automatic line of credit. If your account drops below zero the bank will cover the payment and then charge you interest, plus a fee for using the overdraft. A line of credit avoids the fee and is usually at a lower rate of interest.
4. Secured vs. unsecured
There are two types of PLCs – unsecured or secured. A secured line of credit, backed by GICs or the equity in your house, lowers the risk to the bank so you get a lower interest rate, lower monthly payments and a significantly higher limit. This can save you hundreds a year if you plan to use a significant amount of credit.
5. How big a limit?
A personal line of credit limit can range from $5,000 to $500,000 or more depending on whether it is secured or not and on other factors: your credit score, your income and the amount of your other outstanding financial obligations, like car payments, mortgage payments and other loans.
6. Ease of use
You can write cheques, withdraw cash at an ATM or move money around among your other accounts. Just remember, you’re borrowing money and whatever you spend has to be paid back.
Lines of credit come with a much lower interest rate than most credit cards, usually 1 to 3 per cent above the bank’s prime rate, versus up to 28 per cent for some department store credit cards. But keep in mind rates are variable, meaning they float with the bank’s prime rate. As interest rates rise and fall, so does the rate on your line of credit. If you run up a big balance when interest rates are low, this can come back to bite you if rates move higher.
8. Using a line of credit for investing
The advantages listed above make lines of credit an attractive way to borrow to make an investment. You can make the minimum payment until it is time to sell and (hopefully) realize a gain – and then the interest you paid on the amount used to buy the investment is tax deductible. Some advisers also recommend borrowing to make a larger RRSP contribution before tax time so you get a bigger tax refund, provided you can pay the money back before you rack up too much interest.
You can purchase line of credit insurance, so that in the case of injury or death your payments can be suspended or the balance covered. Insurance can be purchased as a percentage of your outstanding balance amounting to just a few dollars a month, depending on the level of protection or benefits you choose. You can buy the insurance from your lender or from another source like an insurance company, which may be a cheaper option.
10. Avoid the debt spiral
Know your own limit: It can be tempting to buy that bedroom suite you’ve had your eye on, or to treat a line of credit like additional income. Even a good strategy, like using a line of credit to pay off a high-interest credit card balance, can prove dangerous if you allow yourself to run the credit card balance back up again and get caught in a debt spiral.
By Chris Carter