What is a line of credit?

There are more ways to access credit than the standard personal loan with a set term. A line of credit may offer an alternative to borrowers looking to get cash without some of the traditional restrictions.

How does a line of credit work?

A line of credit works a little bit like a credit card in many ways. Once you are approved for a line of credit, you can borrow money up to a specific limit, and make repayments when you choose.

Unlike a traditional personal loan that charges interest on the loan balance, your line of credit loan lender will only charge interest on the credit you have used out of the overall credit limit. This can make a line of credit a competitive option for those looking for flexible access to funds to help pay for a renovation or a family holiday without having to add fixed personal loan repayments to your budget.

The minimum and maximum amount you can borrow with a line of credit will vary depending on the lender and your financial situation. Generally, the more proof you can provide that you’re a reliable borrower, the more money a bank may feel comfortable lending you. You can typically borrow less money with a line of credit compared to a personal loan, though you’ll have more flexibility available around how you pay the money back.

Like other forms of credit, a line of credit will appear in your credit history and affect your overall credit score. If you’ve had difficulty borrowing and repaying money in the past, you’re more likely to have bad credit, and may find it harder to have a line of credit application approved, compared to good credit borrowers. Also, failing to repay a line of credit will likely negatively affect your credit score, potentially affecting future applications to borrow money.

It's also important to keep in mind that you may need to pay fees and charges as part of a line of credit. Be sure to check the fine print before you apply and add any fees or charges to your budget when calculating repayments.

What are the types of line of credit?

There are a few ways you can use a line of credit; as an alternative to a personal loan, an alternative to a car loan, or as a home equity loan.

Unsecured Line of Credit

A personal loan allows borrowers to access a lump sum of money (usually between $5000 and $100,000) to be repaid over a set period (usually up to 5 years). An unsecured line of credit, or overdraft, may be an alternative for those looking to avoid set repayments and save on interest charges. As a line of credit means you’ll only be charged interest on the credit you access, as opposed to a full personal loan amount, this may be more economical in some financial circumstances.

Home Equity Loan

A secured line of credit loan, also called a home equity loan, is a flexible loan that acts similarly to a credit card. A home equity loan (sometimes called a home equity line of credit or HELOC) is a way to draw down on the equity in your home loan. Home equity loans are  typically used for similar purposes as personal loans, such as paying for renovations, medical bills, urgent repairs, weddings, and holidays.

What is a Line of Credit Loan?

What can you use a line of credit for?

Much like a loan or a credit card, you can use a line of credit to access funds for a variety of personal reasons. The good news is that you don’t need to have this purpose approved by the lender before you apply.

Some Australians may use a line of credit to pay for:

• Buying a car
• Home renovations
• Starting a business
• Holidays
• Weddings
• Funerals
• Student fees and costs
• Medical bills
• Veterinary bills
• Dental work
• Legal costs

The limit is up to your imagination. If you can prove to the lender that you meet the eligibility criteria, can service a line of credit responsibly, and are unlikely to miss repayments, then you may be able to be approved for a line of credit

Some homeowners may use a home equity loan to access the equity in their mortgage to pay for home renovations and improvements. In some cases, these improvements may then help to further increase the value of the house, boosting the level of equity in the home.

What alternatives to a line of credit are available?

The two main alternatives to a line of credit are a personal loan or a credit card. It may be worth assessing whether either option may be a better fit for your financial situation.

Personal loans

A personal loan may help borrowers in need of cash get access to funds to be repaid over a set period. It may be secured against an asset, potentially resulting in a lower interest, or remain unsecured. The main difference between a personal loan and an unsecured line of credit is that a personal loan will have a pre-set loan term over which you’ll be expected to pay back the money you’ve borrowed.

Credit cards

As a line of credit essentially acts as a credit card, only with lower average interest rates, it may also be worth looking into low-rate credit cards or even interest-free credit cards, which may allow you to pay for that big ticket item while avoiding high interest charges. Just keep in mind that if you opt for a card with an interest-free window, if you do not pay off the balance within the set timeframe you will be charged a revert interest rate, which is typically much higher than average.

Scenario: Jane wants to renovate her home

Jane has been living in her home for several years and has decided now is the time to renovate. She does not have all the funds available, so she’s considering her options for financing

Here are three potential ways she may be able to finance her home renovations, assuming her finances are in order, and she meets any eligibility criteria:

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