Ask questions via twitter! Message any question to @answers on twitter. We'll publish the question and send you a reply each time there's a new answer.

Warning About Money Questions


 

Mahalo Answers is a great place to start your research into Money questions, but it's not the final answer.

Mahalo Answers is not a substitute for informed professional advice. If you desire or require professional advice, please consult a qualified provider who is licensed in your state or country. You should always seek independent professional advice before acting on any opinion, advice, or information available on Mahalo Answers.

 
 


Next Question

Answered Question

bvienneau bvienneau
 
M$1 January 17, 2009 03:25 AM

Whats the problem with a line of credit?

I see and hear about many people racking up their lines of credit and ending up owing large amounts of money. What causes this to happen? Why doesn't this happen with Loans?

Do you hear this happening to people as well? Anyone have supporting material

Interesting Question?  Yes (1)   No (0)   
RSS
 
 

Best Answer  Chosen by Asker

michaelpau... michaelpau...
 
 January 17, 2009 03:39 AM
Hey bvienneau,

Generally, loans are a fixed amount of money given from the lender to the borrower. The problem with a line of credit is that the amount you are able to borrow can be--and often is--increased on an as-needed basis. Often times you don't even have to ask.

For example, say you buy a home with a loan for a specific amount: thepurchase price. Say some years down the line you run into trouble and need some assistance paying your loan. You could go get a 2nd loan, but more often than not, banks are willing to simply re-negotiate the terms of the original amount--they might let you skip a payment (but still charge you interest), they might let you pay a little less this month, but the idea is that the amount you borrowed generally doesn't increase. (Careful, though, because there are loans that reverse amortize, if you can believe that one.)

Not so with lines of credit. I started out with a measley $500 credit line and soon saw it blossom to a $17K credit line. Why? Because I kept using my credit card. I never once asked for an increase in my credit line.

But that's the problem, in a nutshell: lines of credit can be increased, and when they increase, some people decide to fill up the extra room with things they don't necessarily need, or, life's expenses if they experience the loss of a job/income.

What causes people to rack up debt with lines of credit? Well, part of the problem is that people like the low, monthly payments, which, as you probably know, results in paying far more for all those purchases (in the form of interest) than the original amounts. Another factor, I fear, is that some people simply don't track their finances very well, or feel like they can spend like drunken sailors because they have all this money (that isn't theirs) waiting to be spent.

The bottom line is that lines of credit are only the enemy if used irresponsibly because they have the opportunity to increase your debt, unlike traditional loans, which have a lot less likelihood of doing the same.

Hope that helps.
Source(s):
Years of personal experience.
http://debtsettlement.edu.uscaonline.com/9/the-top-three-reasons-people-rac...
http://www.destroydebt.com/forum/t/542-commons-reasons-for-credit-card-debt...



Helpful Answer?  (4)   (0)    Tip michaelpaul for this answer
Permalink | Report
   Reply  
 
 
robbrown robbrown
 
January 17, 2009 11:30 AM
What a smart answer

Report
 
 
philipy philipy
 
January 17, 2009 12:18 PM
Superb answer.

Re people that don't track their finances well... unfortunately this is not an innate human skill like walking or talking, so it doesn't come easily to everyone. Even the best of us benefit from having tools that make it easy to see what the heck is going on.

That's one reason I like to use cash. The signs show up very obviously in your wallet if you've spent more this week than you allowed for!

Report
 
 

Other Answers (5)

Sort By
mmdmurphy mmdmurphy
 
January 17, 2009 03:28 AM
The problem is that people can't control themselves

Helpful Answer?  (1)   (3)    Tip mmdmurphy for this answer
Permalink | Report
   Reply  
 
 
bbrookin bbrookin
 
January 17, 2009 03:51 AM
On the business side, a line of credit is often useful for ordering short-term supplies or shipping costs. Businesses have come to rely on them for their daily business capital, however. The problem comes when, like now, banks decide they simply won't lend. Daily operating capital dries up. Ships sit in harbor, loaded and unable to sail. Essentially, the business becomes dependent on the bank to conduct their operations.

Helpful Answer?  (1)   (0)    Tip bbrookin for this answer
Permalink | Report
   Reply  
 
 
alanfalcon alanfalcon
 
January 17, 2009 04:58 AM
The simple answer is this: By opening up a line of credit, you're exposing yourself to high amounts of risk. Also, you will see something you can't afford, think you have the money for it, then buy it anyway. If you could afford it you would be able to buy it without a line of credit.

Remember this: Credit is the most aggressively marketed product in America. Why is that? Because the people who offer credit are the ones who make money.
Source(s):
http://www.daveramsey.com/


Helpful Answer?  (1)   (0)    Tip alanfalcon for this answer
Permalink | Report
   Reply  
 
 
ssmacd ssmacd
 
January 17, 2009 02:12 PM
The problem isn't the line of credit--its people that lack self-control. A line of credit is a great financial tool, if used wisely.

Every homeowner should have a home equity line of credit for the maximum the bank will authorize. They key is to use it wisely--many people may never use it all. A line of credit should not be used for discretionary items that are outside of your budget-a big screen tv, dinners out, a a vacation...using it for that wil get you into trouble.

But if your car dies--and you don't have the cash to buy a new ne--having a line of credit in place gives you the option to shop around for the best deal on the car itself--independent of financing.

A home equity line of credit gives you the option to take out a loan for a major item and have the interest be tax deductible.

And lastly, if you lose or job, or have a personal disaster, it gives you the flexibility to take some time to figure out how to restructure your financial life, without having to make instant decisions to sell your house.

Its an important tool in your overall financial life.

Helpful Answer?  (1)   (0)    Tip ssmacd for this answer
Permalink | Report
   Reply  
 
 
navy2001 navy2001
 
January 20, 2009 02:27 PM
I have heard of people racking of their lines of credit and it can happen for a number of reasons.

Sometimes, when you open a bank account, you are automatically extended a line of credit in order to avoid overdraft fees.  Many people don't even know they have it until they get the first bill.  But here's where people get into trouble:

Let's say you were to overdraft by $5.00.  Instead, your line of credit is set to advance you $100.  Now, you effectively have a $100 loan with the bank because you went over your balance.  Once that happens, many people figure that as long as they can pay that payment, then it's okay because they are not being charged overdraft fees.

A much simpler solution would be to have overdraft protection linked to your savings account.  Usually, in that case, they only take out the amount necessary to cover the check or debit.

Of course, keeping your accounts balance avoids that too, but we're only human.

The other line of credit people get in trouble with are home equity lines of credit.  It is kind of an open-ended loan where nothing is triggered until you use the money.  And while you may have the best of intentions with that money, you almost never end up using it for its original purpose.  Not only that, but people feel like it's some sort of windfall of money and forget they must pay this back.  They've taken the equity out of their house, for whatever reason, and now their ability to keep their house is based on their ability to keep up with these payments.

Regardless of how you get the line of credit, it's easy to see the slippery slope it can lead to.  We all like to think we wouldn't do that, but it happens.

I hope that clears things up for you

Helpful Answer?  (0)   (0)    Tip navy2001 for this answer
Permalink | Report
   Reply  
 
 

Answer this Question

How tips and payments work

This question has already been resolved. You may add an answer to it but you will not be eligible to win best answer or any associated tips.

Related Questions

View All Money Questions

Ask a Question


140 characters left
Top of Page
Buy Mahalo Dollars with Credit Card or PayPal

Top Members

This Week All Time
  • buddawiggi
    buddawiggi
    2nd Degree Black Belt
    27933 Points
    M$806.66 Earned
  • opher
    opher
    Purple Belt
    4757 Points
    M$203.72 Earned
  • annelisle
    annelisle
    Purple Belt
    3308 Points
    M$99.72 Earned
   See All
 

Most Popular Tags

mahalo(1641)
twitter(957)
music(469)
iphone(468)
google(363)
food(328)
internet(310)
online(298)
beer(281)
money(267)
movies(266)
apple(253)
facebook(244)
aotd(235)
answers(231)
health(222)
video(210)
free(208)
dog(205)
windows(198)
   See All
 

Categories

Welcome New Members


 
 
Mahalo Dollars are the currency of Mahalo Answers.

Each Mahalo Dollar costs $1.

Once you earn more than 40 Mahalo Dollars, you can request to be paid via PayPal. Each Mahalo Dollar is currently worth $0.75 when paid out via PayPal. Learn More

 
 

Please log in to use this function.

Answers Home | Ask a Question | Earn Points | How Tips Work | Widget