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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

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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...



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robbrown robbrown
 
January 17, 2009 11:30 AM
What a smart answer

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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!

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

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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.

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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/


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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.

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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

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