Personal Line of Credit

A Line of Credit is a tool for those who have a good credit score/rating. Because you have a history that shows that you understand and have managed your budget and your balance sheet properly, you have the financial savvy to handle a flexible loan. You can borrow against it any time up to your given limit. You can pay part of it off or all of it off when your financial situation allows. If you do have an outstanding balance you have to pay a minimum payment every month. It may be as simple as just paying the interest accumulated each month.

Your income patterns may be erratic where you have projects that pay every 2 or 3 months so the cash can get low while waiting for a payday from a big project. Having a line of credit saves you time and saves the bank time. The bank trusts that you will get paid so why would they waste their time and your time negotiating a loan every time you need some bridge financing. You save time because you are busy on your project instead of applying for loans when you need them. The lender knows you are low risk for missing payments. They will not incur costs to pursue payment of the debt. They pass that savings on to you in the form of a low interest rate on the line of credit.




















Unsecured Lines of Credit

If you have a strong balance sheet and a good credit history banks and other institutional lenders will give you a line of credit with a limit as high as in the tens of thousands of dollars and require no lien against any asset that you may own. You should use them for short term cash flow solutions. When the cash flow problem is solved and it should be in the short term, you pay the line of credit balance back to $0. Only in exceptional circumstances should it be used to finance consumer spending.

Secured Lines of Credit

When you have significantly paid down your mortgage you may choose to give yourself some budgetary freedom by negotiating a secure line of credit. The lender will hold a lien against your home and you can negotiate a line of credit with a limit in the hundreds of thousands of dollars. You may have a portion set aside to cover paying off the first mortgage and then the rest is yours to manage. Those who have achieved this level of financial competence may have project in line for that money. It may be a renovation or the purchase of another asset like a cottage. It may be for an investment that has a much higher return than the interest rate charged by the lender.



Lines of credit are a powerful budget tool. If you have many credit card balances you can consolidate them by paying them off with a line of credit. You reduce your interest costs per month because you will pay a lower interest rate. Most lines of credit have the option that you can pay off just the interest incurred as your monthly payment. This is particularly helpful if you have a slow income month. In the good months pay down the balance and reduce interest costs on your budget costs going forward. By lowering your budget costs you will not incur costs for going over credit card limits or overdrawing bank accounts. You can devote some of the extra room on your budget to saving.

If you use the borrowed money to invest, you want to invest in something with a cash flow component so that you at least cover your interest cost. An example is to buy value stocks that pay dividends. The dividends offset the interest cost and the increase in the value is your profit.

These are just two examples of how flexible and useful a tool a line of credit can be when managed properly.



Compared to a mortgage where your home stands as an offsetting asset, lines of credit lines of credit usually stand alone as a liability on your balance sheet. Therefore the impact is that they reduce your net worth. As the user of a line of credit need to manage it so that you build assets with the money you save on interest and by properly investing the borrowed funds.

In our previous example of paying off credit cards, you can improve your net worth by paying off your credit card debt with the money you have saved on interest. You can pay the same amount as you used to pay each month to service the credit cards. You may not increase the asset side of your balance sheet but you lower your total debt liability with each monthly payment. The net in your net worth will increase.

If you borrow the money to invest you need to make more than you pay for interest. If you borrow at 5% and the return on your investment is 10% you net 5%. If the dividend services the debt to buy a stock and the stock goes up, your net worth goes up. Conversely, if the stock goes down so does your net worth.



And Lines of Credit

This tool is particularly helpful for accomplishing financial goals in your life plan. It can help you accomplish them sooner rather than later. It also allows you to accomplish goals in other aspects of your life. One example is for financing “training events” in your child’s life. I think this would be a family goal. Your child may need a musical instrument or need to participate in a very important sporting event that may change their lives. Using a line of credit to cover the short term cost is a much cheaper alternative compared to many other financial products that you might consider using.

Conclusion

This is a powerful borrowing tool for the regular Joe or Jane Doe.. Use it wisely to continue to improve your personal financial position and power.

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