Lines of credit in Canada can be valuable financial tools that offer flexibility, financial stability, and growth when used for personal or business endeavors. However, if one doesn’t know how to use their lines of credit effectively or cannot manage them appropriately, it can lead to mishaps and long-lasting negatives.
To help you ensure you’re using your lines of credit wisely, we’ve put together this guide. It explains what lines of credit are, their benefits and drawbacks, the differences between personal and business lines of credit, and tips for using your line of credit responsibly.
What is a Line of Credit?
Lines of credit are known as flexible loans that can be secured or unsecured. This type of loan is usually offered by banks and financial institutions and typically only to those who qualify and have a good credit rating. However, unlike a typical loan, a line of credit is like a regular credit card in that it has a set limit since you get a defined amount of money that you can access when you need it, and you can use it however you want.
With a line of credit, you can use as much or as little of the funds as you want, and you can pay back what you owe at any time. You’ll only need to make monthly repayments on the interest on the money you borrow. For most people, lines of credit are seen as lower risk than using a credit card, but this loan type is not as common.
However, you must know that lines of credit, whether personal or business, differ from traditional loans in that they typically carry variable interest rates. This means that as broader interest rates change, so can the interest rate you pay, making it difficult to determine how much the line of credit will cost you in the long run.
It’s also worth noting that you can lower the interest rate you pay if you can offer a lender an asset as collateral. This is one of the best ways to keep your payments on the lower end.
Personal vs Business Lines of Credit
A personal line of credit is for those who want to secure funding for personal expenses. In contrast, a business line of credit is designed exclusively for small businesses’ short-term work-related expenditures.
With a personal line of credit, an individual’s eligibility, interest rates, credit limit, and terms are primarily determined based on their financial stability, credit history, and income. On the other hand, for business lines of credit, a lender evaluates the business’s profitability, credit history, and credit score, and revenue during the application process to determine eligibility and credit limits.
Additionally, with a personal line of credit, the individual (you) is responsible for repaying the borrowed funds, whereas with a business line of credit, the business is accountable for repayment.
Benefits and Drawbacks
As with most forms of financing, there are benefits and drawbacks to personal lines of credit and business lines of credit. Besides the obvious advantage of both types of lines of credit allowing only interest to be paid on funds borrowed, below, we have shared the pros and cons of both:
Pros
- Fee Avoidance: Sometimes, those who take out a line of credit with the same financial institution avoid paying fees. With some banks, it’s even possible to transfer a chequing account overdraft to a line of credit.
- Flexibility: A line of credit in Canada gives you the freedom to borrow only the amount you need when you actually need it. You don’t need to commit to a fixed loan amount that could cause you financial strain.
- Emergency Funding: When cash flow is tight or an emergency arises, a line of credit can help you cover unexpected expenses and bridge financial gaps. This is especially true for businesses.
Cons
- High Interest Rates: An unsecured line of credit will have a higher interest rate, and even if you choose a secured line of credit, you will still encounter variable interest rates that fluctuate.
- Fees: If you don’t take out a line of credit with your bank, you may incur setup, usage, and annual maintenance fees. This can significantly increase borrowing costs.
- Debt Accumulation: Unfortunately, since lines of credit offer greater flexibility, it’s easy to overspend, especially when there is no clear-cut repayment plan in place. This makes it incredibly easy to accumulate debt and encounter financial strain.
Tips for Responsible Use
Since it can be challenging to responsibly manage a personal or business line of credit in Canada, it’s a good idea to learn a few tips. Below, we’ve put together the tips for responsible use that you’ll want to keep in mind to avoid unnecessary financial pressure:
Realize Your Line of Credit Can Impact Your Credit Score
How you use your line of credit, whether business or personal, can affect your credit score and health. Unfortunately, irresponsible use of your line of credit can lower your hard-earned credit score, making it more difficult for you to increase your credit limit or secure more financing in the future.
That’s why it’s incredibly important to manage your credit appropriately to maintain a good credit profile. The best way to do this is to avoid maxing out your credit limit.
Only Borrow What You Need
You should always borrow only the amount you actually need and can comfortably repay when you secure a line of credit for personal or business use. Many people make the mistake of giving in to temptation when offered a high credit limit. They pay for it later when they cannot pay off their line of credit due to high, fluctuating interest rates.
To be on the safe side, assess your financial situation and consider why you need a line of credit before agreeing to a credit limit. By doing this, you can responsibly maintain control over the debt you accumulate and pay things off more easily.
Make Routine Payments
If there is one thing you never want to do, it’s fall behind on repaying your personal line of credit or business line of credit. Although these are flexible loans, you can still encounter late fees and penalties if you fail to make regular minimum payments on time.
In addition to paying on time, it’s essential to pay more than the minimum to pay off your debt faster and reduce overall interest charges. This doesn’t mean you have to pay hundreds or thousands more; even a little extra can go a long way toward managing your debt responsibly.
If you think you might have trouble with paying installments on your line of credit, set up automatic payments or create reminders for yourself. Over time, routinely paying back your line of credit will build your credit score and show lenders you’re low risk in the future.
Key Takeaways
Lines of credit for personal or business use can offer funds when you need them most and give you the flexibility to take out only what you need. However, they do have their risks, such as fluctuating interest rates and the very real potential for debt accumulation.
That’s why it’s important to weigh the pros and cons and keep responsible management tips in mind if you’re seriously considering a line of credit. If you are interested in exploring alternative financing solutions, you might want to consider a merchant cash advance (MCA) with Bizfund.
This option is better than a line of credit if you need immediate access to a large sum of money and don’t have a strong credit score. It’s also worth considering if you prefer flexible payments that are tied to your sales volume, which a business line of credit doesn’t offer. You can learn more about merchant cash advances here.
