Lines of credit can provide versatility but there are risks to consider Part of the Series Running a Successful Small Business
When you need money, you may consider getting a personal loan, which provides a lump-sum amount. However, if you don’t know exactly how much money you may need, you may want to consider a line of credit.
A line of credit is a revolving loan that allows you to access money as you need it up to a certain limit. You can borrow up to that limit again as the money is repaid. Learn more about what a line of credit is, about the different types, when to avoid them, and how to use them to your advantage.
A line of credit can be an extremely useful financial tool, providing access to funds when needed. However, lines of credit come with responsibilities. So what exactly happens if you don’t use your line of credit? Let’s take a look.
Overview of Lines of Credit
A line of credit is a pre-approved loan from a bank or lender that allows you to borrow up to a certain limit whenever you need. It works similarly to a credit card in that way. You don’t have to use the full amount, and as you pay back what you borrowed, that amount becomes available to borrow again.
Lines of credit are revolving and can be used repeatedly. They provide flexible access to funds for personal or business purposes. Common types of lines of credit include:
- Personal lines of credit
- Home equity lines of credit (HELOCs)
- Business lines of credit
Lines of credit give you liquidity when you need it. But they are loans, so you do need to make at least the minimum payments each month. Failing to do so can result in consequences.
Consequences for Not Using Your Line of Credit
So what happens if you simply don’t use your line of credit at all? Or only use it very minimally? Will you lose it?
In most cases no. Having an unused line of credit available does not necessarily mean the lender will take it away. However there are some potential ramifications to be aware of
Commitment Fees
Some lenders charge a commitment fee on unused lines of credit. This fee compensates the lender for reserving those funds for you. It may be a monthly or annual fee charged on the unused portion.
Higher Interest Rates
Not using a line of credit could potentially cause the lender to increase the interest rate. This makes the line of credit less affordable if you do need to use it.
Lower Credit Limit
The lender may decide to lower your credit limit on an unused line of credit This reduces their reserved capital while still keeping the line available if needed
Line of Credit Closure
In some cases, a completely inactive line of credit for an extended time may lead the lender to close it altogether. This is more likely with business lines of credit than personal.
Communication with Lender
Lack of communication about your intentions with the line of credit may cause the lender to view the inactive line negatively, Maintaining open dialogue helps ensure the line stays active
The potential actions really depend on the individual lender’s policies. But in most cases, reasonable, periodic use of the line should be sufficient to keep it open.
Consequences for Not Repaying a Line of Credit
More serious consequences can come from not making payments on an active line of credit loan. If you use the funds but fail to repay as agreed, several things could happen:
- Late fees and increased interest rates
- Credit damage from missed payments
- Suspension of the line of credit
- Collection calls and letters
- Potential legal action
- Setoff from other accounts at the same bank
- Long term credit impacts making it harder to borrow in the future
Not repaying a line of credit is a much more significant issue than simply not using it. Payments must be made on time and as agreed.
Tips for Managing Your Line of Credit
To avoid issues, it’s recommended to:
- Use your line of credit periodically to avoid inactivity.
- Make at least the minimum payments every month on time.
- Pay down full balances when possible to keep credit open.
- Communicate regularly with your lender about your usage needs.
- Read all account agreements carefully so you understand the terms.
- Contact your lender immediately if you anticipate problems repaying.
Lines of credit provide valuable access to funds as needed. But they must be managed properly by making payments on time and keeping the lender informed on your usage. An unused line isn’t necessarily a problem, but a delinquent one certainly can be. Maintaining open communication and upholding your end of the borrowing agreement will help ensure your line of credit remains available.
Problems With Lines of Credit
Like other loan products, lines of credit have benefits and risks to consider. Firstly, if you have poor credit, you may not even get approved for this product. And, if you do, youll have to pay the money back and make sure you can afford to make those repayments.
Some banks will charge a maintenance fee (either monthly or annually), even if you dont use the line of credit, and a transaction fee every time you draw money. And interest starts accumulating as soon as money is borrowed. Because lines of credit can be drawn on and repaid on an unscheduled basis, some borrowers may find the interest calculations for lines of credit more complicated. You could be surprised at what you end up paying in interest.
The cost of borrowing money can be expensive, particularly if you take out a personal line of credit that is unsecured. Offering lines of credit without collateral is riskier for lenders and that generally means higher interest rates and greater difficulty getting your request for credit accepted.
The alternative is also risky. Home equity lines of credit (HELOCs) use your home equity as collateral. This reduces borrowing costs but means if you default on payments the bank or financial insutition has the right to take possession of your home. In other words, you could end up homeless.
Lines of credit can be useful in situations where costs may not be known upfront. Personal lines of credit may also be part of an overdraft protection plan.
Pros and Cons of Lines of Credit
- Access to instant, ongoing funds
- Potentially great way to finance projects that have unclear costs
- Similar flexibility to credit cards but with lower interest rates
- Can be secured or unsecured
- Often harder to qualify for than personal loans
- Variable rates of interest make it harder to predict your costs
- Lines of credit can carry a number of fees and confuse borrowers
- For more competitive rates, need to offer collateral
HELOC Explained (and when NOT to use it!)
FAQ
What happens if I get a line of credit and don’t use it?
After you’re approved and you accept the line of credit, it generally appears on your credit reports as a new account. If you never use your available credit, or only use a small percentage of the total amount available, it may lower your credit utilization rate and improve your credit scores.
Should I close a line of credit I don’t use?
Generally there’s no reason to close it out as it’s not costing you and can serve as an anchor for your credit availability which is a good thing.
Do credit lines close if not used?
But after a certain period of time, which varies depending on the lender or creditor’s policies, they may consider your account “inactive” and it may be closed.
What will happen if I don’t pay my line of credit?
“Payments that are 30 days or more past due will result in negative credit reporting, which can lower your credit score and impact your ability to secure future financing,” cautions Calixto. The impact can be severe.