Everything You Need To Know About Line of Credit

Line of credit is meant to be used in times of emergencies or if you really need it. It shouldn't be relied upon to spend just because you have it, okay? And that's very important because you may think that just because you have this line of credit, you have money that you can access. But remember, this isn't your money, okay? It is money available to you. That's someone else's money that you're actually borrowing.

Hey everyone, this is Sukhman here and Teran. And today we're going to be speaking about a little bit of a different top. We're going to be speaking about lines of credits. Now this is a topic that we get a lot of questions about. So the goal today is to let you guys know about things like what is a line of credit, how do you get one, and what can it even be used for? So stick around to the end of this video and I promise by the end you will be an expert on what line of credits are and how they work.

A line of credit is a pre approved amount of money that you can borrow from a financial institution. Institution like the bank right down the street or the bank you are using today. What you can borrow is a certain limit. So it'll give you a certain limit to access and you have the flexibility to borrow and repay repeatedly. So here's an analogy to help you visualize what a line of credit is. So imagine a line of credit as a tap for your finances. Just like you would turn on a tap to access water when you need it, you can access the line of credit when you feel you need to use it. Okay, up to a certain limit. It's like having a reservoir. So reservoir, water. It's like having a reservoir of money that you can dip into whenever you have a need for it and then turn it off when you don't need to use it.

So there's usually two main types of lines of credit. One being an unsecured and the second one being a secured. So an unsecured line of credit is usually a line of credit that you get that is not secured against anything as collateral. So the interest rate might be a little bit higher. Now a secured line of credit is the exact opposite. So something like a car loan, you might actually have a line of credit secured against the vehicle. Or there's another type of line of credit specifically for homes, which is called a home equity line of credit or a HELOC for short. Which basically means that the amount of money that you have access to is secured against your actual home that you have.

So to get a line of credit, what you need to do is you need to apply with the financial institution like a commercial bank, where you provide relevant financial information and undergo a credit check to determine your eligibility for a line of credit. The approval process may vary depending on several factors, such as your credit history and your income, and depending on the type of line of credit you are trying to get. For example, with the home equity line of credit, the value of your home also has an impact on the amount of line of credit you can get.

Now we're going to talk about the types of lines of credits that there are, and we briefly touched on this before, but to go a little bit more in depth, types of lines of credit includes a personal line of credit, a commercial or business line of credit, or something like a home equity line of credit. So all these lines of credits are there for you, but they serve a different purpose. So if you're somebody that has a business and needs to access money to conduct business and to finance the business expenses, you will go get a business line of credit. Conversely, if you're someone who has a personal expense and you just want to have that extra security net like Taran was speaking about before, you might go and get a personal line of credit, whether it's secured, whether it's not. That's something that we touched on before. You can go down both avenues in whichever one is best for you.

So now we're going to talk about the pros and cons of lines of credits. The pros include flexibility in borrowing. It can have lower interest depending on the line of credit you go for, as compared to say, something like a credit card. Credit card interest rates are fairly high nowadays, around 21, 22%. And typically with line of credit, and I'm talking about Canada, lines of credit can go anywhere from 7 to 12% in today's interest rates environment. Interest rates do have an impact on that, on the rate, so keep that in mind. Another pro for lines of credit is to have some potential tax benefits from it. For example, if you have a business line of credit, if you use that line of credit for reinvesting into your business or for business expenses, typically what you could do is you could be eligible for a write off on the interest in the line of credit. Again, your accountant will know more, but that's typically some of the benefits available to you. And then there are other benefits as well. Like I said, depending on the line of credit that you get. Now, there may be some cons as well. For when you have a line of credit, for example, the cons can be collateral involved for that line of credit. So in the case of a home equity line of credit, the collateral is your home. So technically you're putting your home on the line. So if you feel confident in using that line of credit and knowing that you will pay it back and you can pay it back over time, then you may be comfortable using or having your home as the collateral there. Other cons include variable interest rates. The interest rates, like I said earlier, depend on the interest rate environment that you're in. So if the central bank does increase or decrease the interest rates, then that could have an impact on the rate on your line of credit. So that's something to be aware of and that can change overnight. All right? And then lastly, the temptation to overspend line of credit is meant to be used in times of emergencies or if you really need it. It shouldn't be relied upon to spend just because you have it, okay? And that's very important because you may think that just because you have this line of credit, you have money that you can access. But remember, this isn't your money, okay? It is money available to you that's someone else's money that you're actually borrowing. The temptation to overspend can be there. And it's important to be aware of it and not fall down the path of using it just for frivolous spending.

Now that we know the actual pros and cons to a line of credit, let's actually look at some real life examples of how you can use one. So the first one that I'm going to talk about is a entrepreneur who's running a business who's actually using the line of credit to finance some unexpected business expenses for the time being, while things are slow and maybe sales aren't as, as consistent and not coming in through the door all the time like they usually would. So maybe for the two to three months, what this business owner can do is actually dip into the line of credit, the commercial line of credit. Use that to run the business and pay off expenses like rent, inventory, marketing, wages, whatever the case is. But then they know that maybe after the summer months are over, September to December is when their busy season comes, and they can actually take that revenue and go and pay down that line of credit. Now, the key thing I want to touch on here is what Tran talked about earlier. The business owner in this example is using this very, very consciously. They're using it for a goal, which is to finance the business expenses for a certain amount of time, and they know that they will have money in the future that they can use, then pay this down. It's not something like they're just going to use and then forget about it. It's not free money. It's money that you are being offered that you do have to pay back. The second example I'm going to touch on is the home equity line of credit, or heloc. In short, let's talk about a scenario where maybe a homeowner wants to renovate the basement, or a homeowner wants to renovate a room and then put that up for rent from a tenant that they will then get rental income from. Now, in this example, maybe they will take out a loan and use the home equity line of credit to pay for this for the first two or three months. But once that's finished, they know that when a tenant comes into the building that they will be getting a revenue from that tenant that they can then use to again pay down that balance that they have on that. He like, right? Because Tran made a very good point. You are securing your house for this line of credit. So if you do not pay it back, the bank has every right to sell the home and actually make up the amount of money that they have lent to you. So you do need to keep that in mind. In conclusion, lines of credits offer flexibility, convenience, and access to funds when you need them. Whether you're a business owner, a homeowner, or an individual with financial goals, exploring the options available to you can help you make an informed decision to achieve any of your objectives.

If you want to learn how you can create your own personal line of credit, then check out the video here to learn more about the infinite banking concept, which will give you some ideas on how to create your own line of credit where you're not relying on the commercial bank for the money, but you're actually creating your own system of access to capital through this process of becoming your own banker. So check this video out right here.