Lines of credit are attractive because they offer incredibly low-interest rates and have flexible repayment options. However, in recent years, statistics have shown that Canadians are using lines of credit to fund their increasingly expensive lifestyles. In fact, according to the Certified General Accountants Association of Canada’s 2011 annual study on consumer debt, 60 per cent of all consumer debt is financed through lines of credit.
Lines of credit are often masked as good debt because they offer low rates. But, unless they’re used to purchase assets, which are expected to grow (education, investments and businesses), and they’re paid off quickly, lines of credit are not good debt.
Because lines of credit are easy to qualify for and access, they encourage debt accumulation, not faster repayment. There’s no pressure from the bank to pay off the principal; simply cover the interest. You can even borrow back everything you pay toward it.
A low-rate line of credit doesn’t solve a systemic overspending problem, it facilitates it. You know you’re abusing your line of credit if you’re blowing your budget on unplanned purchases and can justify it because you’ve got a low rate; if your bottom line isn’t growing, but your line of credit balance is; if your credit card is racked up each month because of overspending and you pay it off with a line of credit rather than cash; if your home renovation triples in size or if you’re expediting the purchase time frame on major items like a car.
If you’re serious about reducing your line of credit, modify your repayment plan so that the available credit reduces by the same amount as your payment – in essence turning it into a traditional loan. Also consider collapsing your home equity lines of credit into a fixed-rate mortgage.
I only recommend lines of credit in the case of a home emergency when you need immediate access to cash.