There are three main types of credit:
- Open Credit
- Installment Credit
- Revolving credit
Open credit lines are used for bill payments and don’t increase your credit score. Secured and unsecured loans are installment credit accounts, lines of credit and credit cards are revolving credit accounts. The difference is that installment credit is locked in and paid in monthly payments. Revolving credit means you can keep using the credit limit and paying it off as many times as you like.
How Does a Line of Credit Work in Canada?
In short, a line of credit is a type of loan that has a preset limit. The great thing about a line of credit is that it doesn’t have to be used for a certain purpose, and you can save however much of the allotted amount that you choose.
The main difference between a loan and a line of credit is that you only have to make interest payments on the amount you have borrowed each month, and you can pay down the principal at any time you choose.
Unlike a personal loan, there are usually fees on a line of credit, such as registration or administrative fees. The interest rate on a line of credit is usually variable, unlike a personal loan,n which is fixed.
To access money from a line of credit, you can either:
- Write a cheque
- Use an ATM
- Online banking
- Telephone banking
- Transfer into your chequing account
To pay back a line of credit, typically all you have to do is transfer the money from your bank account to the line of credit account.
Secured and Unsecured Line of Credits
Just as there are secured and unsecured loans, there are also unsecured lines of credit. What is the difference?
Unsecured
These lines of credit will give you access to funds without collateral. These are the hardest types of lines of credit to obtain. The bank takes a higher risk when they give you access to cash advances, so while your interest rate will be lower than most personal loans and credit cards, it will be higher than a secured line of credit.
Secured
The most common type of secured line of credit is a HELOC, or home equity line of credit. Because you are offering up your home as collateral, you could end up having a higher credit limit. The limit on a HELOC is based on 80% of your home’s value minus the amount owing on your mortgage. This is the maximum amount that you can borrow.
While it is easier to obtain this type of line of credit, you should be certain you can make the monthly payments. If you default on this, you could lose your home.
How a Line of Credit Impacts Mortgage Approval
Whether you have a balance on your line of credit or not, having a line of credit still reduces the maximum amount that you’re able to borrow. Your debt service calculation ratios generally use a 3% monthly payment based on your outstanding balance or a percentage of your credit limit.
Having a higher line of credit balance can make it even more difficult to get a mortgage approval. This is the case whether you have a traditional LOC or a HELOC (Home Equity Line of Credit). Having a high balance can also influence your credit score. This is because it’s a form of revolving credit, and a high balance can give you a high credit utilization ratio, which can lower your credit score.
To improve your chances for approval and meet your financial goals, qualified borrowers have no or minimal missed payments on their credit report. This is because your payment history is a big part of your credit history.
How Quickly Can You Get an Approval on a Line of Credit
With a traditional bank, it can take anywhere from several days to several weeks, depending on the lender. However, if you’ve been banking with one place for a while, you can sometimes get an instant approval, as long as you don’t have a low credit score and meet the requirements based on your financial situation.
Freezing a Line of Credit Temporarily
If you’re experiencing a reduction in cash flow and having a hard time managing debt, then you can put a pause on your payments. This can help temporarily reduce your financial stress. Speaking with your bank can help them arrange the best solution for you.
Another case where your line of credit may be frozen is if you don’t use it. The bank can freeze the line of credit or reduce your limit due to inactivity.
Joint Vs Individual Lines of Credit
The main difference between a joint and individual line of credit is who is responsible for making minimum payments. With an individual LOC, only one person is responsible, but with a joint LOC, more than one person is responsible. No matter who spends the money with a joint LOC, all parties are responsible.
What Happens to a Line of Credit After Death
In Canada, when someone dies, the line of credit is frozen, and the outstanding balance is to be paid by the deceased’s estate. No family members will be responsible for making the repayments unless the LOC was joint. If the LOC was individual and the estate didn’t cover the amount, the bank would write off the remaining balance.
Lines of Credit and Grace Periods
Unlike with credit cards, there aren’t any grace periods when you pay interest on everyday purchases. Most credit cards tend to have a grace period of 21 days, and if you pay the balance before then, you won’t be charged any interest. That said, you pay less interest on borrowed funds with a line of credit.
Line of Credit Interest and Tax Deductibility
In Canada, interest on a LOC or HELOC is tax-deductible if the funds are used for business investment purposes. Really, they can be used for any reason to earn income. For other purchases, such as everyday spending, debt consolidation, major purchases, and other personal purchases, the interest charges aren’t tax-deductible.
How Banks Calculate Your Line of Credit Interest
In Canada, when you’re charged interest, it’s calculated daily based on your outstanding balance. This is done using a variable percentage rate divided by 365, and while interest is calculated daily, you’re only charged interest once per month, based on your billing cycle.
Best Canadian Banks for Unsecured Lines of Credit
While many Canadian banks offer great lines of credit, here are some of the best options.
| Bank | Credit Limit | Interest Rate | Annual Maintenance Fees |
| Tangerine | Up to $30,000 | 2.99% for the first 3 months | None |
| Scotiabank | $5,000 to $30,000 | Prime + | None |
| RBC | $5,000 + | Prime + | None |
| CIBC | $5,000 + | Prime + | None |
| National Bank | $5,000 + | Prime + | None |
While lines of credit aren’t for everyone, they can help fill cash flow gaps in your chequing and savings accounts. They can also help you avoid higher-interest debt, resulting in a lower total interest paid.
How Closing a Line of Credit Impacts Your Credit Score
Closing a line of credit affects your credit score in two different ways. First, if it’s a long-standing account, cancelling it can decrease your credit age, so your credit tends to drop. It can also decrease your score by decreasing your credit utilization. That said, by making a lump-sum payment, you can continue building your credit history. Once you close an account, though, it can still stay on your credit report for up to seven years.
Personal Line of Credit vs a Credit Card
The main differences between a personal line of credit and a credit card are the interest charged and how the money is repaid. With a personal line of credit, you can access the money directly from your bank account and only have to pay the interest. There is likely to be a lower interest rate on a line of credit, and there is no time limit for repaying the total amount borrowed.
With a credit card, there is a minimum monthly payment you have to pay that likely only goes towards the interest. Interest rates on most personal credit cards are quite high; however, if you pay them off before your statement date, you do not have to pay any interest. For this reason, they are better for small purchases and are easy to carry around. Plus, you can also earn rewards.
Business Line of Credit vs Credit Card
While the principles for business loans and credit cards are the same as those for personal ones, they are used correctly to help track business expenses and reduce the cost of organizing a business.
Because business credit cards provide a breakdown for monthly expenses, that’s what they are best used for. They work the same as receipts for things like gas purchases and other things. While it is best practice to keep your receipts, having the credit card statement lets you know what receipts you should have and gives you a secondary form of documentation.
A business line of credit is best used for large purchases. Be sure to keep the receipts for these as well. The business line of credit allows you to pay it back whenever you like, just like a personal line of credit, and likely has a much lower interest rate than a credit card, which is why it is great for large purchases.
Advantages and Disadvantages of a Line of Credit
When it comes to getting a line of credit, there are many advantages that make it more desirable than other forms of credit.
- They have lower interest rates that are based on the prime rate set by the Bank of Canada.
- Depending on the financial institution, you may not be charged a set up fee.
- It is possible to get your chequing account overdraft transferred to your line of credit.
On the other hand, there are some disadvantages to getting a line of credit.
- The ease of access. This makes it super easy to rack up your debt.
- The variable interest rates. If interest rates rise a lot, it could make a line of credit really difficult to pay back.
Advantages and Disadvantages of a Credit Card
While people generally are advised to stay away from credit cards, there are some advantages to using them if they are used correctly.
- They are convenient. If you need money in a pinch, you have it.
- They build credit. If your credit utilization is kept in a good ratio, usually recommended to be 35% or lower, then it can be very beneficial to your credit score.
- They have affordable currency conversions if you find yourself in another country.
- They can be a great way to build rewards and get discounts.
While there are some good things regarding using credit cards, there are also some disadvantages.
- They have really high interest rates if they aren’t paid before the statement date.
- Some have annual fees on top of the high interest rates.
- They charge a fee for late payments.
- They encourage overspending, which can lead to high amounts of credit card debt.
Can You Pay Off Your Credit Card With Your Line of Credit?
Due to the fact that a line of credit is able to be used for whatever purpose you need, you are able to pay off your credit card with a line of credit or even a personal loan (which can include a home equity loan). While you do still owe the money, you are able to decrease your interest rate, making the debt more affordable to pay off. If you have more than one credit card to pay off, it can consolidate your debt into one affordable payment, allowing you to get debt-free faster.
How Does the Interest on a Line of Credit Work?
The interest on line of credit’s work much differently than that of credit cards. Banks take the prime rate set by the Bank of Canada then they add a percentage on top of that. For example: when you look at an interest rate of a line of credit it will say prime + whichever percentage the bank has chosen. This is what makes interest rates variable since the prime interest rate is always changing.
With a line of credit, you only have to pay the interest monthly and then pay principle whenever you choose. With a credit card, there is a set monthly payment.
What Credit Score Do You Need to Get a Line of Credit?
In order to get a line of credit it is recommended to have at least a credit score of 670 or higher. This means you should have a credit score in the good credit range. The reason for this is because the bank is essentially giving you a cash advance that isn’t secured.
This means you can take the money out and put it back whenever you choose. In order to approve your for a line of credit, the bank needs to have confidence that they can trust you to pay the money back and be financially responsible.
How Do You Know if Your Credit Score is High Enough?
In order to find out where your credit score stands, you have quite a few different options.
- Download a free credit score app. There are multiple different platforms that will give you an estimate of either your Transunion or Equifax credit score. While this won’t be the most accurate since it is just a soft check, it will give you a good idea of where you stand with your credit report.
- Check you score through online banking. Many financial institutions will offer a free credit score right through your online banking. This is essentially similar information to what you can find through the credit apps.
- Check with the credit bureaus. Just like the banks and apps, both Transunion and Equifax offer updated monthly soft credit checks right on their website.
By checking your credit score before you apply for a line of credit, you will be able to determine if there is a likelihood of approval. Once you submit your application the financial institution will go through a hard credit check which will slightly lower your credit score. If there is little likelihood of you receiving an approval, you can always take some time to improve your credit score before you submit your application.
Are You Better Off Using a Credit Card or a Line of Credit?
This is a difficult question to answer. Whether it is better to use a credit card or a line of credit depends on what you intend on using the money for.
Large Purchases
If your intention is to buy something large like a vehicle, a boat or even furniture, you are better off using a line of credit. While you can get a cash advance with a credit card, there is an interest rate increase for a cash advance whereas it stays the same with a line of credit. They are meant for cash advances.
Everyday Expenses
When tracking everyday expenses or using for small purchases, this is where you prefer a credit card. You can pay these off before the statement date every month and avoid any interest payments. They also allow you to track your spending with monthly statements.
Earning Cash Back
When it comes to earning cash back, rewards and in some cases even interest free payments for a few months, a credit card is the best choice. It is important to weigh the positives and negatives but if you are financially responsible with your credit card and earning cash back, then that is the way to go.
Is a Personal Line of Credit the Same Thing as a Credit Card?
This is where things get tricky. While credit cards and lines of credits are different traditionally, credit cards are essentially lines of credit but line of credits aren’t credit cards.
To explain this a little better, a credit card is just a type of line of credit that has higher interest rates. A line of credit in itself does not need a credit card to be active and can be used specifically for cash advances.
Which is More Difficult to Get: a Line of Credit or a Credit Card?
Line of credits are traditionally more difficult to get than credit cards. Credit cards are normally the first form of credit you get when you are able to start obtaining credit lines. While they may start out at a lower limit, you can increase it over time once the credit card issuer recognizes that you make your payments on time.
Lines of credit are more difficult to get since they have lower interest rates and higher limits. Lines of credit do require some form of credit history and normally require you to fall somewhere between the good credit and excellent credit range.
What is a Secured Credit Card and How Does it Work?
When it comes to credit cards, there are many different types, including traditional credit cards, rewards credit cards and secured credit cards. Secured credit cards require a cash deposit in order to determine your credit limit, which is one of the key differences between them and traditional cards.
The main reason to get a secured credit card is to help build up your payment history and improve your credit score. Over time, this can help you get more credit with other financial institutions.
