This is a good question and not one in which people understand very well when thinking about their financial lives. When you think about your finances and you think about buying different products in your life, you have the need for a loan at times and you will need for a line of credit at times. Let's discuss when it is wise to use a line of credit versus when it is better to get a loan. To give the technical definition, a loan is money lent to you for a certain period of time with a fixed interest rate and a fixed monthly payment. You know when you will have the loan paid off at the time that you take out the loan and your paperwork will reflect this fact. Your mortgage is a good example of a loan. When purchasing a car you obtain a loan. You can discuss with the car dealer or your banker the terms that best fit you and what you want the life of the loan to be. Of course the shorter the life of the loan is the less you will pay back in interest. Of course, all of your monthly payment is not going toward paying down the principle of the loan. Much of that payment is applied to interest. At the outset, the majority of the monthly payment you will be applied to interest. As time goes by this changes and you begin to pay more towards the principle each month. A line of credit works differently in that it is an amount of money available to you to use when and as you see fit. You may set up a line of credit without having a specific purpose for the money at the time. Interest rates for lines of credit are figured based on prime, which is established by the Federal Reserve. Hopefully this article can help you understand the difference between a loan and a line of credit. It is important to understand the difference between these because each of these financial products has its uses and its place within your financial life.
There's a reason why lines of credit are so popular: they let you draw money only when you need it, without having to borrow a big lump sum, and they offer flexibility on your monthly payments. Unfortunately, having access to all that cash can sometimes tempt you to overspend. Combine overspending with a period of rising interest rates and, before you know it, your line of credit can begin to spiral out of control.
If all this sounds far too familiar, don't despair. Here are some strategies to help get your borrowing back under control:
Pay more than the required minimum
Lines of credit require only a small minimum payment each month, often as low as interest only. While this is one of their greatest conveniences, paying the minimum each month ensures your debt will continue indefinitely. One of the best ways to manage your line of credit and stay in control of your debt is to pay down some of the principal every month.
Refinance to a home equity loan
If you are a homeowner, perhaps your credit line is secured against the value of your home. The good news is that by having a home equity line of credit, as opposed to an unsecured loan, you are getting one of the best possible rates of interest. However, if you find yourself lacking in self-discipline and tapping your credit line to make impulse purchases, you may want to think about refinancing to a home equity loan. You will continue to get the benefit of a lower interest rate, but the money will arrive as a lump sum, which you can use to pay off your line of credit. And because you will no longer be able to draw additional funds without going through the procedure of applying for another loan, it will help remove the danger of overspending. Unlike your line of credit, a home equity loan is also amortized, meaning you pay the same amount each month, and your payment is a mixture of principal and interest. This forced discipline will help you pay off your debt faster.
Consider cash-out refinancing
Another option to consider is cash-out refinancing. This involves taking out a new mortgage with a higher principal than your current one, and then using the extra cash to pay off your credit line. As with a home equity loan, you will receive a lump sum. And you won't be able to access more money down the road without refinancing (or taking out a home equity loan or line of credit). The advantage of this option is that first mortgages generally carry a lower rate than home equity loans. Plus, you'll have only one credit payment each month instead of two.
Lock into a fixed-rate loan
Interest rate trends may influence which option is better for you. When rates are rising, it may make more sense to switch to a fixed-rate home equity loan. This is because your line of credit carries a variable interest rate. So if rates are headed upward, locking in may be a good idea.
At the same time, if you took out your primary mortgage when rates were lower than they are now, cash-out refinancing may be less attractive as you may be unable to refinance for as low a rate as you have now. Of course, in an environment of falling rates, the reverse would be true. If current interest rates are lower than they were when you took out your mortgage, cash-out refinancing may provide you not only with the cash you need to pay off your line of credit, but also with a lower rate on your mortgage.
Both William Blake & Chris Navi are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
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Chris Navi has sinced written about articles on various topics from Buy a Franchise, Finances and Mortgage. Chris Navi - For more information about Home Equity and Lines of Credit go to . Chris Navi's top article generates over 49500 views. to your Favourites.