Is a Line of Credit Really Like Cash?

Many people wonder if getting a line of credit is the same as having cash in hand. At first glance, they seem similar – you have access to funds that you can use when needed. However, there are some key differences between a line of credit and cash that are important to understand.

What is a Line of Credit?

A line of credit is a type of revolving loan that allows you to borrow money up to a pre-set limit. The bank or lender approves you for a maximum amount, say $10,000, that you can draw from as needed. You only pay interest on the amount you actually borrow.

As you make payments, that money becomes available to borrow again Lines of credit have a set time period, usually several years, during which you can access the funds This flexibility makes lines of credit useful for covering costs that are ongoing or unpredictable.

Lines of Credit Provide Revolving Access to Funds

One of the best things about a line of credit is that it can be used over and over again. With a term loan, you receive the full amount upfront. You only take out what you need when you need it with a line of credit.

For instance, if you get approved for a $10,000 line of credit, you don’t have to take out the whole $10,000 right away. You can take out $2,000 to pay for an unexpected medical bill, and then next month you can take out another $1,000 to fix your car.

You can use the money you borrowed again once you’ve paid it back. This type of revolving credit makes lines of credit easy to use and adaptable.

You Must Repay What You Owe

While a line of credit gives you easy access to money, it is still a loan that must be repaid, with interest. It is not free cash. Any amount used needs to be paid back according to the loan’s terms.

Not paying your bills on time will hurt your credit score and probably get you fined. You can choose when to use the money from a line of credit, but not whether you pay it back in the end.

Interest Accrues Immediately on Money Borrowed

With a line of credit, interest starts accumulating as soon as you draw money, unlike a credit card which has an interest-free grace period. This means costs can add up quickly.

It’s important to only borrow what you need and pay back balances as soon as feasible to minimize expensive interest charges. A line of credit gives access to funds but should be used responsibly.

Borrowing Limit is Preset Based on Your Qualifications

While lines of credit provide ready access to money, there is a cap on how much you can borrow. The lender will approve you for a set loan amount based on factors like your income, credit score, and current debt levels.

For example, you may get approved for a $20,000 line of credit, which allows you to borrow up to $20k total, not per transaction. With cash, there is no pre-set limit on how much you can spend or withdraw (besides what’s in your account).

Upfront Application Process is Required

To get approved for a line of credit, you need to fill out an application with a lender, documenting your finances and creditworthiness. It is not automatically available like cash.

The lender will likely check your credit report and score to qualify you and set the terms, including the interest rate, credit limit, and repayment structure. There is no lengthy application for using the cash you already have.

There May Be Fees and Penalties

Opening and using a line of credit may incur fees such as:

• Annual or monthly maintenance fees
• Transaction fees for accessing funds
• Penalties for late payments
• Prepayment penalties if you pay off the balance early

Qualifying can also be challenging for borrowers with poor credit histories. Cash, on the other hand, does not directly involve fees or credit checks.

Secured vs Unsecured Lines of Credit

Lines of credit can be secured or unsecured:

• Secured lines require collateral like a house or car. This provides the lender security in case you default.
• Unsecured lines do not require collateral. This makes borrowing easier but interest rates are typically higher.

Cash is not tied to collateral. You can use cash for anything without putting other assets at risk.

When Are Lines of Credit Useful?

While not an exact substitute, lines of credit can provide valuable flexibility:

• Covering emergency expenses
• Funding home renovations or repairs
• Paying taxes
• Consolidating higher interest debts
• Business investments in equipment/supplies

For large or ongoing costs, lines of credit may provide affordable access to capital. But they work best for borrowers with good credit and disciplined repayment habits.

The Bottom Line

While lines of credit give you revolving access to money like having cash, they are loans, not guaranteed funds. Fees, limits, credit checks, and interest charges apply. Lines of credit can be useful but have risks and should be used strategically as part of an overall financial plan, not as free spending money.

When used properly, lines of credit offer a convenient way to access extra funds without taking out individual loans for each need. But it’s important to clearly understand the terms and repayment responsibilities. A line of credit supports flexible borrowing, while cash provides outright purchasing power.