When you need cash, is it better to obtain a line of credit or get a loan? The answer depends mainly upon your self discipline and what you plan on using the money for. If you want to make fixed payments over a specific period of time, then a traditional loan is your best option. If you prefer to have a line of credit that you can use whenever you need to as long as you have money available, then a line of credit is probably the route you want to take.
Loans work in the same manner as a home mortgage for the most part. You borrow a specific amount and you make monthly payments for ten to thirty years. Many people will opt for a fixed rate loan when they borrow money to start a business or improve their home. You can borrow from your fixed rate loan one time. That means, even if you’ve paid back half of the loan, you cannot simply call the loan lender and ask to re-borrow the half you’ve paid back. You use it, you lose it!
On the other hand, a line of credit is much more flexible and allows you to do just that. Basically, whatever your maximum line of credit is, that’s how much you can borrow by writing a check, and in any amount up to that total. So if you have a line of credit for $30,000, you can write checks for $1600, $2000, $8000, or more- as long as the total amount of money you use is less than $30,000. Then, as you start making payments on the amount of money you’ve used from your line of credit, you can immediately reuse that money again. Many people who are unsure of how much money they are going to need, or know they will need irregular amounts will often select a line of credit. A line of credit is a good option for college tuition, buying a new car, or just knowing you have access to cash when it’s needed.
Somewhere between a line of credit and a fixed rate loan is a home-equity line. For most home-equity lines, the loan period is actually divided into two different segments. The first is called a “draw” period, and lasts about five years. During this period of time, you are able to borrow money as you need, similar to a line of credit. As you make payments during the “draw” period, the amount of credit available to you is increased by the amount of your payment. When the draw period of your home-equity line ends, you will either be required to pay back all of the outstanding balance in a single, lump sum, or you will pay the outstanding balance back over a fixed period, with fixed payments just as you would a regular loan. Your contract will include the details for what happens during the “payback” period of your home-equity line- and are things you should understand before you sign the papers for the money.
In addition to the convenience of having these extra funds for whatever you need the money for, in some cases, you can deduct some or all of the amount of the loan or line of credit on your taxes. If you are improving or purchasing your home, you can deduct up to $1 million dollars! Basically, the government will subsidize the cost of borrowing the money if you use your home to secure the loan. If you pay $770 in interest and you can deduct that in the 27% income bracket, the federal government is going to pay about $200 of that interest. In some states, you can also claim the interest on your state tax returns, and increase the amount of your deduction.