Line of Credit Loans: Dangers & Risks

A line of credit loan is a loan that provides a way for a borrower to access funds on a short-term basis to meet certain funding needs. A line of credit loan can include a cash line that is based on a predetermined amount, home equity loan or line of credit and overdraft protection for a borrower’s checking account.

A line of credit loan is a way for a borrower to meet their short-term needs and should be viewed as a way to help pay for gaps in funding. The dangers and risks associated with this type of borrowing include their improper use or overuse by a borrower that may lead to a lowering of the borrower’s credit score or potential loan default.

Used Improperly

The availability of a line of credit loan can be a source of relief to a borrower who has short-term needs that arise from time to time. The problem with lines of credit are that when a borrower comes to rely on them too much and use them to meet all of their financial needs, they become expensive and may lead to financial problems. The interest rates on a line of credit loan are typically higher than the rates charged on conventional loans. Over time, this rate can add up, making the cost of a line of credit loan more expensive to the borrower.

Lower Credit Score

Taking out multiple or frequent line of credit loans will affect the credit score of the borrower. Each open line of credit that results from taking out a loan represents an amount at risk should it not be paid back. This risk is assessed by the credit reporting bureaus as a basis for the borrower’s creditworthiness. A borrower with many loans outstanding represents a greater risk than a borrower that has a few loans.

Potential Loan Default

If a borrower uses a line of credit loan as a means for frequent and regular borrowing, it is possible that the total amount of debt outstanding could cause loan default. Some borrowers may view line of credit loans as free money, much in the same way some credit card users view their spending limits. Since the main purpose of a line of credit loan is to provide a way for a borrower to access quick money to meet a short-term need, caution should be exercised in order to prevent a mounting debt from occurring.

Lines of credit should be carefully managed by a borrower in order to provide the benefit that they are designed for without affecting the borrower’s ability to take out future loans.

 


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