You might have heard the term “line of credit” before. Maybe you have a vague conception of what it means. This article will explain exactly what a line of credit is and how to get one. We’ll also discuss when applying for a line of credit can benefit you.

What is a Line of Credit?

A line of credit is a set amount of money that a bank or another lending entity extends to you. You can use it as needed. For instance, you might get a line of credit equalling $5,000. Once the lending entity extends it, you can borrow from it as needed, up to but not exceeding $5,000. Like a traditional loan, you will typically be expected to pay a set interest rate on that line of credit if you decide to use any of it.

How to Get One

Before you ask for a line of credit, it’s best if you have your finances in order. If you owe money, for example, and you’re looking at debt consolidation, it’s probably not the best time to approach a lending entity to ask about this option.

Assuming your finances are in good shape, the traditional way to get a line of credit is to approach a bank or credit union. These are respectable lending entities, and they might be willing to extend you a line of credit if you can convince them of your reason for needing it.

Why Would You Need One?

There are several reasons why you may pursue a line of credit. For instance, maybe you’re starting a business where you know you’ll need money, but you’re not sure of exactly how much. Say that you’re getting into house flipping. You might need part of that line of credit to purchase a dilapidated property and the materials to fix it up.

You might also need a line of credit for personal reasons. Maybe your daughter is getting married, and you told her you’d foot the bill. You can use some of the money from the line of credit to pay for her dress, tuxes for the ushers, rental of the facility, etc.

Line of Credit vs. Traditional Loan

You might wonder why you’d want to get a line of credit vs. a traditional loan. The reason is that if you approach a bank or credit union, and they agree to give you a loan for a particular amount, you will immediately have to start paying interest on the total sum you borrowed.

If you get a line of credit, you only start paying interest if and when you use part of it. If you only use a fraction of the line of credit, you’ll only need to pay interest on the amount you used until you pay it back.

Secured vs. Unsecured

There are also secured vs. unsecured lines of credit. The secured version means you put up an asset as collateral. Home equity lines of credit are a common example. You use your home as collateral.

The other version, the unsecured line of credit, comes with no collateral. The lender assumes more risk in this instance.

Consider Whether a Line of Credit Works for You

If you need cash, a line of credit might be a logical move since you only pay interest on the money you use out of the total the lending entity grants you. That’s different from a loan, where you immediately start paying interest on the total amount.

There are secured lines of credit where you put something up as collateral or unsecured ones where the lender assumes more risk. If you need a line of credit, having a credible reason to approach a lending entity is usually your best bet.