Line of Credit

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Line of Credit Cost

The cost of a line of credit is determined by the amount borrowed plus the interest rate charged on it.

The advantage to a line of credit is that the borrower decides how much credit to use. This means that the borrower can limit the line of credit cost to only the credit they need.

The interest rate determines the cost of a line of credit to the borrower. The lender collects interest on a line of credit in order to make a profit off of it. The interest usually covers the lender’s expenses in issuing the line of credit plus the risk they take by issuing the credit and a small profit.

The higher the interest rate the more a borrower will pay for a line of credit. This is why a borrower should always try to get the line of credit with the lowest interest rate possible. The line of credit with the lowest interest rate will have the lowest cost.

Risk and Line of Credit Cost

The biggest factor in determining the cost of a line of credit is the risk the lender takes in issuing it. If a borrower is considered riskier the line of credit cost will be higher.

This is why individuals and businesses will pay more for a line of credit if they have a bad or low credit rating. Those with a bad credit rating are considered higher risks of not paying off the line of credit. The higher interest rate is the insurance the lender takes out against the risk of not getting paid.

Those with low income or unstable sources of income are also considered high risks so they also pay a higher interest rate. Some lenders consider businesses in certain industries speculative or high risk and charge them a higher interest rate. Startup businesses will face a higher line of credit cost because they have no track record to prove they’ll pay the credit off.

Collateral and Line of Credit Cost

The risk is why some lenders demand collateral to secure a line of credit. The collateral is another form of insurance for the lender. It is a piece of property the lender can seize if the loan is not paid.

Collateral can affect the cost of some lines of credit such as real estate or home equity lines of credit. Those who put up a lot of collateral may have a lower line of credit cost.

Equity Loan Line of Credit Cost

In a real estate equity or home equity loan the cost is determined by the value of the property, the amount of equity available, its geographic location and the risk the lender takes. The risk the lender takes is usually determined by the property owner’s credit rating.

Lenders consider real estate in some locations a higher risk so they charge higher interest rates on lines of credit in those areas. Lenders consider those with bad or poor greater risks so those individuals face a higher interest rate.

The amount of equity available is determined by the amount the property is mortgaged for. If the property’s value exceeds the mortgage the property owner has equity. The amount of credit available is usually a percentage of the equity. Property owners with bad credit will be able to use less equity and face a higher cost.