Lines of credit

A line of credit is much like a credit card in that it is a rotating line of credit where you are charged monthly interest and expected to make minimum payments.

The key differences between a line of credit and a credit card are:

• A line of credit does not have fees for cash advances, cash can be taken out just like making a purchase without extra cost.
• A line of credit does not have a grace period. You are charged interest for the money you take out starting immediately.

Beyond these two main differences, lines of credit have a tendency to be lower interest rate and more difficult to get approved for.

A line of credit gives you certain opportunities that you would not otherwise be able to accomplish with a credit card. Primary amongst these is the ability to transfer a debt from one credit account to your line of credit without incurring a fee.

Lets explore some of the ways you can use a line of credit to save money. Lets say your line of credit is 12% interest and has a limit of $6000. If you owe $3200 on your Visa which charges 23% interest you are paying $61.33 every month in interest. Now if you pay your Visa with your line of credit you are now paying 12% which is only $32.00 interest. You are now saving over $30 a month just by moving it over.

Now, lets say there is a $1200 couch you wanted to buy, and it has a 90 day interest free period on it if you use your merchant card which charges 29% interest. You only get your interest free status if you pay your card balance in full before the 90 days is out, otherwise you pay full interest starting at the time of purchase. So lets leave it on our merchant card for 85 days, then pay it in full with our line of credit. That is 85 days worth if interest we do not have to pay, that saves the $34 that our line of credit would have charged interest if we just bought it from the line of credit right away.

This can also be done with the 25 day grace period that many credit cards offer. Please keep in mind that you will not benefit from the 25 days grace unless you pay off your whole credit card balance by the due date. Just paying the amount of your purchase is not enough.

Another advantage of a line of credit is that when you make a large purchase on your credit card it "exercises" your credit, showing a usage that credit companies like. When you transfer this balance to your line of credit you are in effect exercising your credit twice for one purchase. Both your credit card lender and your line of credit lender see you spending the $1200 that you used on the couch, but they have no way to know they are the same purchase. This helps your credit rating.

Not all lines of credit are helpful in reducing what you pay. There is a class of lines of credit that charge very high interest rates but have low monthly payments. They might make you an offer where they give you a line of credit at 32% interest if you transfer the debts from your existing cards to your line of credit then cancel them, they make this sound appealing by showing how your minimum payments will be less if you do all your debt with them.

This is true, they will offer you a lower monthly payment. But lower monthly payments and higher interest equals paying far more. This company is trying to get your debt so they can make money off of you. You cannot use such a line of credit to reduce your overall costs, only to reduce your monthly payments. I don't recommend it, if you are in that dire of need then try credit counseling through reputable organization.

Getting credit with no credit history

It can be very difficult to get your first form of credit. This is because you will not have a record of your borrowing history for creditors to examine. Very few lenders will give an unsecured loan to somebody with no credit history.

How does one get a credit history if they cannot get credit? There are a couple of ways that I know of. Both involve the fact that people may trust you despite a lack of public credit history if they have more local reasons to believe you are trustworthy. This could be in the form of a good relationship with them in the past, or through some sort of collateral.

The way I did it, was to go to the Hudson's Bay Company and apply for their merchant card. Even though I did not have any credit history, I did have a job that could be confirmed by HBC. I was given a credit limit 0f $500 that could only be spent at their stores, the interest rate was a very high 28.8%. Merchants will often take greater risks in lending to encourage sales, but they mitigate these risks with high interest rates.

Once I used that card and kept it in good standing for about 2 years, they raised my limit to $1000, at which time I called them and asked for an upgrade to a Mastercard. I got it. Even though I had no public credit history, I did have a local credit history with HBC which convinced them to lend to me.

Merchants usually do not report your merchant card activity to the public registrars, but they do keep their own records that they can use in their lending decisions. Once they give you a major credit card then they begin to report your credit history publicly.

The other way to establish credit when you have none is to do a secured loan. That is where you put something valuable up as collateral for the loan. It can be a car, and house, savings bonds, or even cash. Even with bad credit one can get a loan that is secured. If one remains in good standing with a secured loan eventually you will qualify for an unsecured loan.

Once you have a proper credit card then a credit history starts to form for you. If you keep it in good standing then you will form a good credit rating.

Credit basics

Credit is a tool that lets you make better use of your income by having access to funds before they are in your actual possession. Using credit you can weight the cost of borrowing against the improvement to one's life.

Imagine a scenario where you wanted a new television, but it would take you a full year to save up for it. You know that you will be able to save up this money in a year, but you want that television now, not in 12 months.

If you have credit you can have the television now for a cost. This cost is called the "cost of borrowing". This cost of borrowing includes all fees, interest, and other expenses related to borrowing.

Lets say the TV costs a total of $750, after tax and recycling fee and delivery costs. You ask the salesman about monthly payments, he does a fast credit check and with luck you are approved. The deal he offers is that you will pay a $25 financing fee up front, then pay $75 a month for 12 months at 29% compounded interest.

Lets look at the "cost of borrowing" here. By using a loan calculator like this one you can determine how much interest you would pay on such a loan. In this case, $750, at $75 a month at 29% interests means you will pay a total of $869.07 in payments. That is a cost of $119.07, plus $25 for the finance fee. That is a cost of borrowing of $144.07.

Financing from a merchant is often one of the more expensive ways to borrow. If you have your own credit card then you do not have to meet the merchants terms, yours are likely better. Lets say you buy the same TV with a credit card that has a 21% interest rate. Once again you pay $75 a month, accept this time you don't pay a finance fee and your interest is 21% instead of 28%. In this case you pay a total of $831.70 making the total cost of borrowing $81.70. This is much better.

But wait, credit cards don't require that you pay a fixed amount, you only need to pay your minimum. The minimum payment on a credit card is often as little as 3% of your total balance. Lets see what happens if you only pay our minimum on our 21% credit card after buying a TV.

When only paying your minimum payment on your credit card you pay a total of $1504.62, making the cost of borrowing $754.62! What happened? The minimum payment pays the interest, but little more. When you make a monthly payment of $22.50, the first $13.13 goes to pay interest and only $9.38 goes to reduce your actual debt. That means in this situation when you pay only the minimum you are only getting 41 cents on the dollar. For every dollar extra you pay that month it reduces you debt by 100 cents per dollar. If you only payed the minimum you would be paying for that TV for 115 months, that is just short of 10 years.

Now lets say we can pay $100 every month. Your debt is payed off in 9 months and you pay a total of $61.10 in interest.

What I am trying to get across is that you save a lot of money by paying an amount significantly greater than your minimum payment. Remember, more than half of your minimum payment goes to that months interest. You will be charged interest again the next month. Once your minimum is payed every dollar you pay further that month reduces your debt by a full dollar.