Lines of Credit

[z3r0]

How do lines of credit work? What is the minimum payment? How long do you have to pay your debt? Is it cheaper than mortgage rates?

-z

[pitz]

How do lines of credit work? What is the minimum payment? How long do you have to pay your debt? Is it cheaper than mortgage rates?


There are various types of LOC's. The big difference tends to be secured, or unsecured. Secured means you pledge some assets, often a house, stocks, or bonds, but sometimes, receivables, and other property, in exchange for a better rate and terms on the loan. Unsecured means that you aren't pledging anything (but they can still seize your assets in bankruptcy court if you don't pay up).

LOC's are typically known as 'revolving credit', in that, there isn't generally a pre-set amortization period over which the debt has to be repaid. You can negotiate various terms with lenders, but typically, most want to at least see 'interest' as cashflow each month.

Typically LOCs are repayable 'on demand'. The bank, for any reason, can demand repayment in full immediately. Keep this in mind if you borrow a lot on a line of credit and get sick or lose your job, the bank can demand the loan be repaid immediately, often at the most innopportune time!. Whereas traditional loans or mortgages cannot be 'demanded' or 'called' in at any time.

The 'end game' of a LOC is, ultimately, death, or lack of credit-worthiness. Someone who is getting old and has no assets and only fixed pension income to secure a LOC isn't very likely to get one. Someone with millions of dollars of quality, liquid assets can easily be literally allowed to die with an outstanding LOC (the estate will have to pay it off.....something that Fraser Smith recommends with respect to the Smith Manouevre). Of course, with a LOC, typically you can walk into the bank and repay it in full at any time. With most other types of loans you are not allowed to do this without penalties.

[GimmeGear]

...
Typically LOCs are repayable 'on demand'. The bank, for any reason, can demand repayment in full immediately. Keep this in mind if you borrow a lot on a line of credit and get sick or lose your job, the bank can demand the loan be repaid immediately, often at the most innopportune time!. Whereas traditional loans or mortgages cannot be 'demanded' or 'called' in at any time.
....

Hey Pitz,

This is news to me, and not very good news. Are they truly able to demand the balance be paid at any time and for no reason? Is there any legal recourse?

[Octavius]

Hey Pitz,

This is news to me, and not very good news. Are they truly able to demand the balance be paid at any time and for no reason? Is there any legal recourse?

Banking is all about contracts. Read the contract you signed when you first opened up your LOC. If it says that the bank can call in your debt at any time then they have the right to do it and you have no legal recourse since you agreed to the terms upon executing the contract.

Typically though...unless you're in a HUGE amount of debt and the bank thinks its interests are being compromised then the bank likely won't be pushing your buttons too much to pay it all back right away. The longer you wait to pay it back (and the more you owe) the more the bank makes off of you in interest.

[dolphie]

Banking is all about contracts. Read the contract you signed when you first opened up your LOC. If it says that the bank can call in your debt at any time then they have the right to do it and you have no legal recourse since you agreed to the terms upon executing the contract.
pretty well every loan document i've ever signed has this as a clause in the fine print. i wouldn't stress too much about it.

[Thalo]

Typically, what happens is that the LOC will just be suspended and you won't be able to draw any more money from it but will be held to the repayment terms. Repayment on an unsecured LOC is usually 3% of the balance each month, just as with a credit card. The next step would be to call it in or send it to collections.

[pitz]

Hey Pitz,

This is news to me, and not very good news. Are they truly able to demand the balance be paid at any time and for no reason? Is there any legal recourse?

Yes.

The bigger implication is that if, for example, the bank runs into a liquidity crisis (aka bank run), the bank will call as many of these LOCs as they possibly can, to satisfy claims of creditors/depositors. No legal recourse whatsoever. And if they *truly* need the money, they will go after even the highest quality customers for cash.

Also, bankers can turn 'sour' on the type of collateral you have pledged. For instance, if the Canadian housing market started undergoing some of the drops like the US market, say goodbye to your nice and cheap home equity-secured line of credit.

[z3r0]

I've been doing some reading and understand that you can make minimum payments towards your LOC debt balance, and even pay interest only.

Can you explain how this "interest only" plan works? How long can you pay "interest only" and how long do you have to pay off your debt?

Thanks
z

[pitz]

I've been doing some reading and understand that you can make minimum payments towards your LOC debt balance, and even pay interest only.


You can do whatever you are able to negotiate with your LOC lender. For good customers with quality pledged assets, bank LOC's are usually written as 'interest only'. Unsecured LOCs typically require at least some part of principal to be repaid along with interest.

In theory, on a LOC, you can just borrow more money to pay the interest on money already borrowed. This does, however, require a monthly trip to the bank (or computer).

Many of these rules are derived from banking regulations, and loan risk classifications. For instance, in theory, there is no difference between skipping payments, and borrowing more (from the same LOC) to make the payments, to either you, or the bank. But banking inspectors will classify such a loan as delinquent, and force the bank to set aside higher loss reserves or increase the risk weight of the loan in their portfolio.


Can you explain how this "interest only" plan works? How long can you pay "interest only" and how long do you have to pay off your debt?


It all depends on the bank. You have to pay the debt off when the bank demands that you do so. If you have good collateral, you can keep paying 'interest only' until your death (after which, your estate will have to settle the debt with the bank, or the bank will repossess the collateral).