A line of credit is a great financial instrument that businesses and individuals use to have constant access to funds. Businesses use it for both short and long term financing for high revenue projects.
Individuals, on the other hand, can use it to finance various expenses and asset purchases over time. In this article, we shall learn about Line of Credit for individuals in detail and FAQs.
What is a Line of Credit?
A line of credit is a kind of loan that provides access to a lump sum amount of money up to a predetermined limit. You can have access to money via online banking or offline.
You can use all the funds or part of it at your discretion. You make the monthly payments on the basis of the usage of the funds.
The money you owe can be paid at any time. You just need to pay interest on the loan you acquire.
Types of Line of Credits?
- Secured Line of Credit (SLOC / Home Equity Line of Credit aka HELOC)
- Personal Line of Credit (PLOC)
What is the Secured Line of Credit (SLOC)?
A SLOC or HELOC (Home Equity Line of Credit) requires individuals to guarantee specific assets as insurance to secure the line of credit. The asset is usually a house, which is why it is also known as the Home Equity Line of Credit (HELOC).
SLOC is a great option for those who are anticipating recurring expenses or one large expense and are hesitant to use their credit cards.
The benefit of SLOC is that you can borrow it at lower interest rates and can access funds any time you want, even if you need to borrow a large sum of money.
Home owners who have built equity in their homes, use a secured line of credits to pay off high-interest credit cards, car loans, or use it to help family members in need, etc.
What is the Unsecured Line of Credit (USLOC)?
An Unsecured line of credit aka Personal line of credit PLOC is a kind of bank loan that equals a credit card.
It’s like you have a lump sum amount of money that you can spend as you want, as long as you don’t surpass the approved limit.
It is called an unsecured line of credit, meaning that you do not have to pledge collateral. As a result, the lender’s risk is higher and so are the interest rates and may charge an annual fee.
In the event of non-payment of the dues on the USLOC account, the bank will have the rights for blocking your limits and the total outstanding will immediately become due.
What is the Line of Credit interest Rates?
Most LOCs are based on a simple interest method as opposed to compounding interest that is used in mortgages. Let’s understand how the rates work and differ with secured and secured LOCs.
What is personal line of credit interest rates?
Personal lines of credit usually have higher interest rates, because it involves greater risk on the part of the lender.
The interest rate is usually 2% or higher than the prime rate. The rate you are offered depends upon your relationship with a bank, your credit, income & debt profile.
You cant choose fixed or variable interest rates. The interest rates offered are variable and they will rise and fall depending on the market.
What are the secured line of credit interest rates?
With a secured line of credit (SLOC), the lower lender’s risk brings a lower interest rate as compared to unsecured LOCs.
The rates offered are usually Prime + (0.5%-1%). When opting for a SLOC, look for an affordable interest rate, repayment terms that suit you, and minimal fees. One also needs to qualify for lower interest rates. Qualification is on the basis of equity in the real estate, overall debt, credit score & income.
The mortgage stress test applies to a secured line of credits.
Line of Credit (LOC) Vs Loans
There are a couple of key differences between a loan and a LOC. A personal loan is a borrowed amount to help you pay for something specific, such as a car.
Interest is calculated on the full credit sum and the debt is paid off in weekly or monthly installments. When you’ve taken care of the loan, you’re done. You can’t acquire any of the funds back again except when you reapply to borrow money.
LOC, on the other hand, lets you get cash whenever you want. When you have a LOC, you can borrow, reimburse and borrow again up to your credit limit without having to reapply. What’s more, you are allowed to utilize the cash for any purpose.
FAQ - Secured Line of Credit
SLOC keeps property as collateral which lowers the risk of a financial institution. The bank/ lender can take over the property to pay the balance. Hence the rate offered is lower & the monthly payment is lower.
The interest rate varies from bank to bank. The average rate is around Prime + (0.50% – 1%). Prime interest rate today is set to 2.45% however Prime rate may also vary from bank to bank.
- An SLOC has the lower rate of interest compared to unsecured line of credit and Private loans.
- With an SLOC, you need to pay the interest only.
- Only a minimum monthly payment is required. You can choose to make weekly, biweekly, semi-monthly or monthly payment at your discretion.
- There are no prepayment penalties associated with SLOC.
- You have anytime access to funds and can use it as revolving credit.
Yes, all major banking and financial institutions in Canada offer SLOC but the terms and conditions vary from lender to lender.
For customized secured line of credits you should speak to your mortgage broker.
Yes, you can still get an SLOC despite having a mortgage. However, you have to meet strict qualification criteria i.e. Mortgage Stress Test.
The maximum loan amount including the first mortgage and SLOC has to be less than or equal to 80% of the appraised value of the house.
If you only want standalone secured line of credit, you can’t get more than 65% of the appraised value of the subject property.
Yes, you can. The maximum amount of SLOC cannot exceed 65% of the appraised value of the property.
You have to go through a qualifying process which tends to be stricter than your regular mortgages
Yes, a lawyer is needed to complete an SLOC transaction. A real estate lawyer will ensure that all previous liens are taken off the title and a new SLOC lien is placed as required by the lender.
An appraisal is required by banks to establish a fair market price of the property. Once the value is established, the bank can approve a standalone SLOC maximum amount of up to 65% of the value or a combo of a first mortgage and a secured line of credit of up to 85% of the appraised value.
What is the difference between Secured and Personal Line of Credit?
- In a SLOC, collateral is a must. There is no such requirement in a PLOC.
- SLOC also gives you a lower interest rate on credit.
- SLOC offers the highest credit limit available to you up to 80% of the value of your home. The lending amount for PLOC ranges from 50,000 to whatever your lender deems loanable.
- The variable is lower in a SLOC than a personal line of credit.
What is better, SLOC, Private home equity loan, or second mortgages?
- SLOC is the best option if you have a home with equity and can qualify on the basis of Credit, income, and debt service ratio
- If you can’t qualify for a SLOC but have enough equity in property then you may consider second mortgages. Caution needs to be practiced when dealing with individual lenders.
- If you need to secure funds at the earliest and prefer to pay minimum payment including principal and interest so that you can pay off your loan faster, then a home equity loan is recommended for you. The interest rate is higher than SLOC buy may work out to be a better choice after all.
Take a look below at quick home equity loan options and how you can benefit from them.
What matters most with a Line of Credit is securing a lower interest rate loan. Having a mortgage and credit expert by your side can ensure that you get a better deal than otherwise.
While you explore your option for secured loans against your home, it’s worth learning on reverse mortgages especially amid COVID 19 pandemic.
Get in touch with Mortgage Delivery Guy to discuss your line of credit options today.