From time to time, many of us will receive notifications from online lenders or financial institutions to share that they have a pre-approved line of credit for us. These are relatively common, although sometimes it is not easy to know what to do when you receive one. Alternatively, you may have not received a pre-approved line of credit and need to borrow money. In this scenario, you probably want to know how to apply for a pre-approved line of credit. You may not know how to go about getting one. Which financial institution do you apply to, for instance? In this article, we share all you need to know about a pre-approved line of credit, and the advantages and disadvantages of accepting one.
What is a pre-approved line of credit?
A pre-approved line of credit is a type of loan which lets you borrow money up to a pre-set limit. You do not have to spend the money on anything particular, and you may use as little or as much of the fund as you like up to its limit. The money can be repaid at any time, although you will need to pay interest on any money borrowed. For some pre-approved lines of credit, you might have to pay an administration or registration fee – check with your financial institution beforehand. The interest on a pre-approved line of credit is typically variable – this means it could increase or decrease over time. With rising interest rates in Canada right now, this is something you should carefully consider before accepting a pre-approved line of credit to ensure you can afford to repay it. This interest must be paid from the time you agree to having the pre-approved line of credit, until the funds are repaid in full. The interest rate can also be affected by your credit score – if you have a good credit score, you are likely to pay a lower interest rate on the funds. In order to access the funds from your pre-approved line of credit, you can either use an ATM, online or telephone banking to pay a bill or move the funds to your chequing account, or simply write a cheque drawn on the line of credit. You will receive a monthly statement showing the amount owed on your line of credit, and you will need to make at least a minimum payment each month. Repaying just the minimum payment, however, will take you a long time to repay the line of credit in full.
What are the pros of a pre-approved line of credit?
A pre-approved line of credit has the following advantages:
- Typically, you will pay a lower interest rate over another form of credit like a credit card or a loan
- You may not be charged fees for administration or setup, although this varies by financial institution
- You may be able to have an overdraft on your chequing account transferred to your line of credit
- Flexibility – much like credit cards, you can pay off a line of credit and then use it again
- Accepting more credit can lower your credit utilization ratio
What are the cons of a pre-approved line of credit?
A pre-approved line of credit has the following disadvantages:
- As lines of credit provide easy access to additional funds, it can lead to spiralling financial issues if you do not control your spending
- You may find it difficult to pay back your line of credit with rising interest rates
- The bank may use a line of credit to withdraw any late payments from you
- Secured lines of credit can affect your home – it may be seized if you cannot make your payments
- You will be locked into long-term monthly payments, which can have an impact on your budget
When taking out a line of credit, it is important to be sure that you can afford it. Just because they do not need to be paid back immediately, it does not mean that you need to use them to capacity.
Which types of pre-approved lines of credit are there?
Generally speaking, there are two key types of line of credit – secured, and unsecured. Below is a summary of each of the kinds of line of credit you can take out:
- Secured line of credit – an asset is used as collateral, like your car or home. If you do not repay what is owed, the lender can take possession of that asset. Typically, you will get a lower interest rate because of the additional security for the lender.
- Home equity line of credit (HELOC) – a home equity line of credit is a secured line of credit where your house forms the collateral. This usually enables you to borrow more at a lower interest rate than most other lines of credit.
- Unsecured line of credit – unsecured lines of credit mean that your loan is not secured by any assets. These include some personal pre-approved lines of credit, and also student lines of credit.
- Personal line of credit – personal lines of credit are due to be used for unexpected bills or for consolidating loans with higher interest rates. The interest rates for personal lines of credit are typically lower than those associated with credit cards or personal loans.
- Student line of credit – these are specifically for those paying for post-secondary education, helping to pay for expenses including tuition, materials, and accommodation.
How does a pre-approved line of credit affect your credit score?
In order to assess you for a pre-approved line of credit, financial institutions will need to run a soft credit check. Thankfully, this will have no impact on your credit score. A soft credit check only gives the financial institutions a rough indication of your credit score to see if you qualify for a pre-approved line of credit. Should you decide to accept the line of credit, a hard credit check will be carried out. This is in order to validate the approval, and this will affect your credit score slightly. If you are to consider increasing your pre-approved line of credit in the future within a year or so you may not need another hard credit check. Your credit report will then be impacted by how good you are at making your line of credit repayments in full and on time. How it can affect your credit score depends on your score before you take on the line of credit, as well as your credit utilization score and debt to income ratio. Provided you do not spend more than around 35% of your available funds, your credit score will likely increase to counteract the small impact of the hard credit check needed to assess your financial circumstances initially.
Is accepting a pre-approved line of credit a good idea?
Receiving an offer for a pre-approved line of credit is one thing; accepting it is another. Really this decision needs to come down to your financial circumstances, and whether or not you can afford to take on the line of credit. You need to consider this carefully, and make sure you can make your payments on time and in full as they are due. If you are unsure, you should not except the line of credit. Perhaps you can afford a reduced amount instead. Another financial institution may be able to offer you a different amount and interest rate that could work much better for you. There are a few questions you should contemplate before accepting a pre-approved line of credit:
- Does it make financial sense to take out the line of credit? Is it required? Are you confident you can make your repayments?
- Will it help or hinder your credit score? Consider your credit utilization rate and its impacts
- Is the interest rate on the line of credit the best that you can find?
If it will serve what you need it to, and the advantages outweigh the disadvantages, it may be a good move for you.
For advice on taking on a pre-approved line of credit, or for help in gaining debt relief, book a free consultation with Spergel. Our experienced Licensed Insolvency Trustees have helped over 100,000 Canadians gain debt relief, and we are here to help you too. For advice on any credit or debt related matters, speak to us today – you owe it to yourself.