Line of Credit 101
Updated on Tuesday, October 29, 2019
How to line of credit like a boss
Years ago we took a step back to look at the products we offered our Customers and thought, Geez can't we do better?!? Thus the decision was made to introduce a line of credit here at LendDirect. We believe this product offers unmatched flexibility and financial control, and is far superior to the installment loans offered elsewhere. But all of those wonderful thoughts are mostly useless if the people using the line of credit don't understand how it works. So in the most exciting way possible, we're going to teach you how to use a line of credit like a boss.
TL; DR - A line of credit is like a credit card but without the plastic. Borrow what you want up to your approved credit limit and pay back as quickly as you like. You can take out more funds as you pay down your principal balance, using your available credit or pay that sucker off and save some moolah. Because math.
Let's start with the basics
A line of credit works a lot like a credit card but without the plastic and with actual money. Once you open a line of credit account, you have access to those funds for as long as you'd like, no need to reapply or refinance or any of that nonsense. As long as you keep an outstanding balance, your line of credit will stay open.
The very first step to getting a line of credit is to fill out an application. If you're approved, the maximum approval amount is your maximum credit limit. So let's pretend you get approved for $5,000 but you only need $1,000 for whatever. We don't care, we're not here to judge you and your excessive wall paper obsession. Just take out the $1,000 and then you have $4,000 of unutilized credit available if you need it later.
Unlike a credit card when you take the $1,000, actual money will be deposited into your bank account so you can take it out as cash, use it to pay bills, etc., etc., you get the picture. You will receive statements prior to your due dates to let you know what your outstanding balance is and your minimum payment. After you make your payment, whatever amount of principal you paid back becomes available to you again. Neat right?! You can withdraw as many cash advances as you'd like up to your full, maximum credit limit.
But you said there would be details
As you would probably expect, there is a lot of math involved with anything financial and a line of credit is no different. Let's take the $5,000 line of credit example above and walk through how you could use it to get that fancy wallpaper job done and then some.
We've already explained that your maximum approval amount is your credit limit, pretty basic. Let's say you're approved for the $5,000 but right now you only need $1,000 for that daring designer wall covering 'cuz you fancy. So you withdraw a $1,000 cash advance and BOOM it's deposited into your bank account. Once you have the funds, the next step is to pay it back.
Now we're getting into the nitty gritty deets
To fully understand how the payments work, you have to understand the two main factors that make up the payment, interest and principal payback.
Interest accrues daily on the amount you have drawn. It is only accrued on your principal balance not on the outstanding interest. A quick way to calculate your daily interest is to take your annual interest rate and divide it by 365. Then take this amount and multiply it by your outstanding principal balance. So if you have a 34.99% annual interest rate on your loan, the rough math would be .3499/365 = .0010 then take .0010 x $1,000 = .96. Every day you have the $1,000 out, it costs you about 96 cents. If you take a cash advance, from the day you take the cash advance and it is deposited into your account interest will start to accrue on your new outstanding balance.
Principal payback is a set percentage of your total outstanding principal. This amount will vary by financial institution so it is important to read your contracts to understand how each individual company you work with assess this amount. But since you are on the LendDirect blog, we're going to be selfish and talk about our process. For this example, we'll focus on monthly payments but the exact math will vary slightly based on your payment schedule. Principal is paid down at a rate of 2% per payment, with a maximum amount of $50 and a minimum amount of $25. The maximum and minimum limits are meant to keep payments reasonable but also make sure principal is still being paid down every month. So on the $1,000 loan, the principal payback would be $25 since $1,000 x 2% = $20 and the minimum amount is $25 and $20 is less than $25. Yay math.
Let's put it all together to calculate a rough payment and understand what that means. First the interest? Annual interest rate/365 = daily interest x outstanding principal x days in your billing period = total interest on your payment. .3499/356 = .0010 x $1,000 =.96 x 30 = $28.80. Now the principal payback! $1,000 x .02 = $20. Is $20 less than $25 or greater than $50? Yep - bump it up to $25. $25+$28.80 = $53.80. On a $1,000 line of credit with an annual interest rate of 34.99% monthly payments are approximately $53.80. Not bad math whiz!
Now we know what you're thinking. Roughly? What trickery are you not telling me about?? Well the answer is nothing is ever that perfect. This example is what we in the biz call a perfect pay period. That means nothing changed on your account, you made your last payment perfectly on time and your statement period was exactly 30 days and you had exactly $1,000 drawn for every single one of those 30 days etc., etc. One tiny little change can change all that math. But bottom line, using this simple math will get you pretty dang close and regardless of if it's 30 days or 10 days, the basic components of your payment will always be daily accrued interest plus principal payback.
Now for some real talk guys and gals. 'Member how we just figured out on that $1,000 every month you'll pay back $25 in principal? Well do this math: $1,000/$25 = 40. That's 40 months to pay back $1,000 if you only make the minimum payment. Whoa. So that low monthly payment is great for those months were you're short on cash but not so great for your long-term financial wellbeing. Make. Extra. Payments. A few bucks here and there will really make a big difference. Seriously. Literally adding just $10 to your payment every month will knock off one year of payments. So maybe do that.
Great! Why would I get one of these with LendDirect?
Because we're so nice! No, that's not why. We know you have options, but the bottom line is this is your life and we understand you want to make the right decision. So from our standpoint, mostly that means making sure you fully understand what you're getting into. If you want to know if a line of credit is the right choice for you check out our blog article about just that! Also if you have questions, please ASK US! We're here to help you be the best you and believe education is the first step. That's all people! Hopefully this helped to demystify line of credits. Stay woke folks.
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The information provided on our blog is for general informational purposes only. All information is provided in good faith, however we make no representation of any kind, express or implied, and should not be considered professional financial investment advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.