Learn more about the mechanics of an unsecured line of credit
An unsecured line of credit is one of the more versatile financial tools available for individuals and small businesses. The way it works is basically a person applies for a line of credit, then the lender assesses their creditworthiness and authorizes them for a line of credit based on how good their credit is. This line of credit can be used immediately, saved for later, or (as is most often the case) used in small amounts, repaid, and used again. If this sounds familiar, this is because you’ve seen this type of credit before–it’s called a credit card.
An unsecured line of credit differs from a traditional loan in a few ways. First off, you can take several small or medium size amounts of money as needed rather than one big lump sum, so you are in essence allowing yourself to take multiple loans with multiple purposes with just one application. Second, you pay interest only on the money you are using, not the amount of money you are approved for. For instance, if you take a $25,000 loan for a year at 6 percent, you will pay $1,500 in interest, even if you only use $10,000 of it, assuming interest is calculated annualy. If you take that $10,000 from your $25,000 unsecured line of credit, you would pay only $600 at the same interest rate with the same assumptions. Finally, a loan often involves collateral, whereas an unsecured line of credit is, by definition, unsecured. You can still get yourself in a lot of trouble if you don’t pay off your loan on time, but the end result will not necessarily be your eviction from your home or the repossession of your car, as could be the case with collateral loans. The down side of an unsecured line of credit is that the interest rates tend to be a bit higher than traditional loans.
The benefits of a line of credit
There are a few specific circumstances where a line of credit is very beneficial to an individual or a small business. For an individual, probably the most popular use for an unsecured line of credit is for home remodeling. Projects like that often involve multiple checks being written to multiple contractors over several weeks or months, and the final amount paid is often nowhere near what the original estimate was. A line of credit gives the flexibility to deal with those issues. Another circumstance in which an individual may want a line of credit is for a wedding, again because there will be multiple checks written to multiple parties over a period of time. For small businesses, an unsecured line of credit is especially valuable during start-up. When a business is just starting out, there are hundreds of expenses that seem to come out of nowhere–there is always one more cost that you didn’t think of. With an unsecured line of credit, a business owner can have the available cash to draw from to deal with those expenses and then pay it back when the business is up and running and (hopefully) making money. After paying off the line, the business still has the opportunity to keep the line open so it can be used as an emergency reserve for sudden unexpected expenses or business interruptions. Flexibility like this that makes it a valuable tool.