From time to time, purchases may crop up that require a more nuanced type of financing than you've used in the past. When it comes to taking on debt for a large project or other financial need, it's important to weigh your options. Luckily, you have choices, especially when you're looking for something that's perhaps more flexible and provides different opportunities than traditional methods.
One example — a line of credit — allows the borrower to draw on their loan multiple times, potentially for a longer time period and with higher borrowing amounts than your average loan. Plus, although a line of credit is a generic name for one type of financing option, there are multiple products that fall under the umbrella of a line of credit that might be helpful to borrowers’ cash flow needs.
Here are some of the key distinctions to keep in mind when determining which type of lines of credit are best for your specific needs.
Line of Credit: An Explanation
A line of credit comes in various forms, each of which has their own distinctions, and they can be used for individuals or businesses. All lines of credit provide the borrower with a set amount of money to use for expenses, typically with the ability to make withdrawals throughout a given period of time (draw period).
In this way, most lines of credit are more flexible than other similar products that provide financing. Still, it’s important to understand the differences between each type of line of credit before settling on the right one for you. Different types of lines of credit include:
- Open-end credit or Revolving line of credit
- Secured credit
- Unsecured credit
- Personal line of credit
- Home equity line of credit (HELOC)
Please note that the above-mentioned lines of credit may not be mutually exclusive. For instance, a personal line of credit may be secured or unsecured.
Open-End vs. Closed-End Credit
Open-end credit also known as a line of credit allows the borrower to make repeated withdrawals throughout the draw period and payments throughout the life of the loan.
Good examples of open-end credit products are credit cards, as well as both personal lines of credit and HELOCs. For these products, once the amount drawn against the line of credit is paid back, the money becomes available to borrow from again - during the same draw period.
In this way, open-end credit is a flexible way to fund financial projects or needs that cost a significant amount of money over a longer time frame. Although it may be convenient to have a continuous line of credit, there may be additional fees associated with keeping the product open. These are often charged either annually, or broken up into monthly installments.
In contrast to open-end credit, a closed-end credit product, also known as an installment loan, provides a borrower with a specific lump sum that they would likely use to pay for a certain product or service upfront. In this way, closed-end credit is less flexible than open-end credit, since it serves a specific purpose and the money must be disbursed in one lump sum, and once repaid cannot be drawn again.
Closed-end credit products allow for money to be lent for a fixed amount of time. Typically, once a closed-end credit is originated borrowers need to make regular, scheduled payments, on both principal and interest, starting immediately thereafter.
Secured vs. Unsecured Credit
Besides the length of availability and flexibility for a line of credit, whether or not a product is secured or unsecured is an important variance, as well. This is the difference between whether or not a borrower will be required to put something down as collateral on the loan. There are a number of considerations to keep in mind for each.
Secured credit is a type of loan wherein the borrower provides a security interest in something of value — otherwise known as collateral — in order to obtain a loan. An example of a secured line of credit is a HELOC, where the customer must pledge their home as collateral for the loan itself. Although the borrowing amount of a HELOC is dependent on how much equity the borrower actually has in their home, traditionally speaking, a secured line of credit is less of a risk for the lender, which often translates into potentially higher borrowing amounts, as well as lower interest rates.
As opposed to secured credit, unsecured credit is more of a risk to the lender, since the borrower doesn't have to put up any collateral to gain the loan. A personal line of credit is a good example of an unsecured line of credit, as well as a traditional credit card. Because of the added risk to the lender, most lenders make underwriting decision based on independent financial factors — like credit score, credit history and income — and may have more stringent requirements for these factors.
Personal Line of Credit vs. HELOC
The fundamentals of these two types of lines of credit are similar in that both provide consumers access to money whenever they might need it during a given period of time, known as their draw period. A major difference between the HELOC vs. personal line of credit is that one requires collateral to secure the loan, while the other doesn’t. Potential loan amounts, fees and interest rates are additional factors to consider when deciding between the two.
Personal Line of Credit
A personal line of credit is a type of loan that offers consumers a specific amount of money, known as a credit limit, from which they can borrow from for a given period of time, which is usually over a number of years. Borrowers can access these funds from a financial institution like First Republic Bank as needed throughout their draw period and, assuming they stick to the terms of the loan, once the amount drawn is paid back, it becomes available to borrow from again during the draw period.
In this way, a personal line of credit is a type of flexible, revolving line of credit. A personal line of credit is a great option for financial situations that require a significant investment over a certain period of time, like making upgrades to a home, or covering a portion of your child’s K-12 education.
Although there is no collateral required for this type of line of credit, there are other considerations to take into account. Qualifications typically depend on financial aspects like the borrower's income, credit history and expenses. There may be additional fees to consider, as well.
For example, an annual maintenance fee ensures that the line of credit stays open during the draw period, and this is often charged either annually or broken up into monthly payments. There may be late fees on delinquent payments, as well as small transaction fees for withdrawals. Although interest rates for personal lines of credit tend to be variable in most cases, at First Republic Bank, the personal line of credit is available at a low fixed rate, which also makes them a good option for consolidating other high-interest loans. It is also important to keep in mind that all fees will be individually set by the financial institution. At First Republic Bank, for example, borrowers pay no origination fees, maintenance or prepayment fees for the life of the loan. (Comparing fees between products is just one of the ways to help find the best personal line of credit for your needs.)
Maximum loan amounts for personal lines of credit are set by individual lenders, but First Republic’s personal line of credit offers anywhere from $60,000 to $350,0001, depending on individual factors.
HELOC (Home Equity Lines of Credit)
A HELOC works similarly to a personal line of credit — offering access to a set amount of cash during a set draw period as a home equity loan — with one big distinction: collateral. To be eligible for a HELOC, a borrower would need to offer their home as collateral to secure the loan. In general, the amount of money available to the borrower will be based on the equity they have in their home, not the overall value of the home itself.
Like a personal line of credit, interest and monthly minimum payments for a HELOC only begin from the point where the borrower makes their first withdrawal. Maximum loan amounts should be considered when deciding between a HELOC and personal line of credit, since a HELOC loan amount is dependent on the borrower’s home equity. Interest rates for HELOCs also tend to be variable, which means that they can fluctuate throughout the life of the loan.
Be sure to inquire about any additional terms and conditions that a lender might have for a HELOC before signing up for one, too. For example, at First Republic, there is no required annual review of a HELOC, and no additional closing costs if the product is closed simultaneously with a First Republic mortgage.
The Final Word on Lines of Credit
With so many financial options out there these days, it can be daunting to figure out which one is the best for your particular needs. Keeping a few of the specific qualifications in mind for each, as well as understanding how they fit in with your particular financial goals, is a good start.
Also remember that just because a product appears good on paper doesn’t necessarily mean it’s the best one for you. The flexibility of an open-end credit product might be appealing to some, but if you worry that a constant access to cash will cause you to spend more than you need to, a closed-end credit product might be better for your needs.
If you’re having trouble deciding, a banker at First Republic can help walk you through the options for taking out a line of credit that’s perfect for your particular goals, whether that’s refinancing student loans, paying for car expenses, covering medical costs or making some minor improvements to your home. A personal line of credit calculator can also help you gain a better understanding of what your rate might be when you're ready to consider taking out a personal line of credit.
1 First Republic Personal Line of Credit minimum is $60,000; maximum is the lesser of $350,000 or debt to be repaid at origination plus $100,000. Line of credit cannot be fully drawn at origination.
Personal Line of Credit consists of a two-year, interest-only, revolving draw period followed by a fully amortizing repayment period of the remainder of the term. Draws are not permitted during the repayment period. Full terms of 7, 10 and 15 years available.
This product can only be used for personal, family or household purposes. It cannot be used for the following (among other prohibitions): to refinance or pay any First Republic loans or lines of credit, to purchase securities or investment products (including margin stock), for speculative purposes, for business or commercial uses, or for the direct payment of post-secondary educational expenses. This product cannot be used to pay off credit card debt at origination.
The terms of this product may differ from terms of your current loan(s) that are being paid off, including but not limited to student loans. By repaying such loans, you may permanently be giving up tax and repayment benefits, including forbearance, deferment and forgiveness, and you may not be able to reobtain such benefits if this loan is refinanced with another lender in the future.
Borrower must open a First Republic ATM Rebate Checking account (“Account”). Terms and conditions apply to the Account.
Contact your legal, tax and financial advisors for advice on deciding whether this is the right product for you. Terms and conditions apply.
Product is not available in all markets. For a complete list of locations, visit firstrepublic.com/locations. Applicants must meet a First Republic banker to open account. This is not a commitment to lend; all lending is subject to First Republic’s underwriting standards. Applicants should discuss line of credit terms, conditions and account details with their banker.
The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document.
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