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There are many different types of lines of credit. The alternatives to investigate depend on what kind of line of credit you are considering and your financial objectives. Most lines of credit are revolving, but not all. Some are used for personal borrowing, for businesses or for overdraft protection on demand deposit accounts. Some lines of credit are secured, and some are unsecured. If you have identified the type of line of credit you are considering, you are more likely to find reasonable alternatives.

What Is a Line of Credit?

In a very general sense, a line of credit is a flexible, open-ended loan made to an individual or a business. Lines of credit are probably most comparable to credit cards. Unlike a traditional installment loan, such as a mortgage or a student loan, you are not being lent a lump sum of money and charged interest right away. Instead, a lender offers you the ability to borrow funds in the future up to a certain maximum credit limit.

You are not charged interest on your line of credit until you actually borrow money. The payments tend to be more irregular than typical lending options. Unless you have a non-revolving line of credit, once you make a payment, you are able to borrow those funds again later.

When a Line of Credit Is Not Useful

There are two features of lines of credit that make them particularly attractive: purchase flexibility and payment flexibility. Like a credit card, these can be used on an as-needed basis and paid off when it is convenient, depending on terms of the line of credit. A line of credit also comes with many of the same risks as credit cards.

Unsecured lines of credit are usually not your best option if you need to borrow a lot of money. If you plan to make a one-time purchase, consider a personal loan instead of a line of credit. Loans tailored to a specific purchase, such as a home or a car, are often good alternatives to opening a line of credit.

Federal regulations on education loans make lines of credit tricky for paying for college. Most financial institutions are not ready to approve open lines of credit for colleges. You probably receive a more attractive rate through a Direct or PLUS loan, anyway.

Before opening a line of credit (or a credit card), always consider whether it would be possible to alter your spending habits and budget more effectively instead of assuming more debt. There are financial and moral hazards associated with open-ended credit accounts. You might be placing yourself or your family in a long-term predicament by turning to credit to solve your financial problems.

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