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How To Figure Out if a Line of Credit Will Work for You

There are many varieties of debt consolidation programs, a frequently used one of which is known as the “line of credit.”

 A line of credit is typically extended by a bank or a lending organization. The actual credit is set up sort of like a combination credit card and checking account. You get a limit and you’re told how much interest you would have to pay and what the repayment terms are. You usually get a checkbook and are told you can write checks that become your loan amounts.

With a line of credit, you can use all or part of it and you control the timing. For example, with a $20,000 line of credit, you may use $12,000 of it right away, pay a lot of that back, then use $10,000 at a later date.

But if you’re already in trouble with debt, how can a line of credit help? Isn’t it just one more debt? Do you really need more blank checks tempting you?

Yes and no. It is one more debt. But if you have set it up at a favorable interest rate, you can now pay off your 22% department store credit card and your 21% furniture loan and your 18% credit card at the lower line of credit interest rate.

Some people end up with a debt consolidation refinance (that is a refinancing of the home mortgage) and still get a line of credit. There’s a reason for this. A refinance can wrap up a lot of debts but these deals may not include every debt. In fact, you may refinance and wind up taking care of several loans, but still have half a dozen credit cards to worry about. The line of credit takes care of anything the refinancing doesn’t.

The amount of debt you may need to consolidate can be larger than the amount you can borrow in a line of credit. For instance, let’s say you have $15,000 in debt to consolidate but you only qualify for a $10,000 line of credit. Lines of credit can work even in this situation.

In this case, you’d take the $10,000 line of credit and use it to pay off a portion of your debts. You’d then work at paying down the line of credit (and also keeping up with your other debts). At some point in the future, you’d have enough available credit on your line of credit to borrow another $5,000 to pay off the other debts.

This strategy of using your line of credit repeatedly is not without some risks, and you need to be disciplined and knowledgeable about this method. In fact, you should really talk to a certified credit counselor to understand how to make this system work for you (rather than against you!)

If you use your line of credit in this way (take out a loan, pay off some debts, pay off the line of credit loan, doing the same thing again), it could very well improve your credit score. Any time you use credit wisely (that is, you borrow and repay promptly) it improves your credit score. Since lines of credit often charge lower interest rate and may even have easier repayment terms, it can actually be easier to improve your credit score than paying off traditional credit cards.

While lines of credit can consolidate your debt and even improve your credit scores, they are not entirely without risks.

If you use a line of credit, you have to be diligent and disciplined about paying them off. If you don’t bother making your payments, your line of credit is just another debt and your situation will get worse instead of better.

If you use a line of credit, you must do everything in your power to reduce your total debt. Don’t take out more loans or get new credit cards. If your monthly payments are lowered, don’t take that windfall and blow it at the mall. Take little steps at home to reduce your expenditures and then apply those amounts to paying off your debt. If you don’t change your attitude about debt, a line of credit is just one more way to wind up owing money.

Last but not least, be careful about how much interest you end up paying on your line of credit. While you can often reduce the interest you owe by consolidating debts and paying them off with a line of credit, this is not guaranteed to be the case. Some lines of credit charge high interest rates, particularly unsecured (no collateral) lines issued to people with sketchy credit histories. Check out the terms of your line of credit before you use it. (For instance, if you get an 18% line of credit to consolidate a bunch of 10% to 14% loans, you’ll end up paying more rather than less!)

Last but not least, the biggest danger in the debt consolidation line of credit is temptation. Having a “magic checkbook” with lots of new checks will make it tempting for you to buy some of the things you’ve been denying yourself because of your credit problems. If you figure out a way to reduce your total monthly payments, you may decide that you “deserve to splurge” the savings that start accumulating. This kind of thinking is what causes debt and if you end up using your line of credit this way, you’ll end up worse off than when you started.

Only get a line of credit if you have worked with a certified credit counselor who has helped you set up some sort of budget or spending plan. If you get a line of credit and don’t have a budget, you are playing with fire. Be very firmly resolved to get out of debt, enough that you stop your old behaviors. Cut up your credit cards. Stop applying for new cards or loans. Economize where you can. You may be throwing money away in a lot of areas that you can use to pay off your debts (now) or use for savings or buying things you want (future).

But when you're ready to start taking control of your financial life again, a line of credit can be one of the most important tools you have at your disposal.

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