Personal Lines of Credit (LOC) have become increasingly popular in recent years. The financial industry has sold the allure of instant access to ‘affordable’ credit to fund large purchases, unexpected expenses, home renovations – whatever we wanted to purchase but could not afford today. The success of this product has been nothing short of amazing. Growth has outstripped credit card debt by more than 5 times over the past ten years. That’s good right? Unfortunately, no. Like with credit card debt, consumers have all too often over-used line of credit debt, finding themselves deep under water and unable to recover.
5 Reasons Why Line of Credit Debt is Bad Debt
Nothing is more convenient than instant access to money. With available credit, it’s all too easy to run up credit balances that you may not be able to repay.
Higher Credit Limits
Home Equity Lines of Credit (HELOC) products are particularly dangerous. Secured by your home, these debt products typically have higher credit limits than you would ever have on your credit card.
Slow Repayment Terms
The repayment terms on most lines of credit are very lax. Some are interest only, at best they are interest plus 3% of the balance. Making payments at this rate will keep you in debt for life.
Interest Rate Risk
While rates are low today, lines of credit are variable rate loans meaning every time interest rates increase your borrowing costs immediately edge higher.
False Sense of Security
One of the most sold features of a line of credit is that you will have access to funds during an unexpected emergency. A better option is to have money set aside in the event you need it. While you may have started out with the idea that your line of credit was to be used only for emergencies, the truth is that, unlike a regular loan, your credit limit is always available — and tempting.
Lines of Credit can be a smart way to borrow. If you are planning a home renovation, using a line of credit to fund the investment may be a lower cost option. But treat that debt just like your mortgage. Pay it off sooner, rather than later. Don’t use your line of credit as a form of revolving debt. You’ll soon be in a cycle you can’t turn off.