Definition of closed line of credit
Definition of closed line of credit

A closed-end line of credit combines the features of a closed-end loan and a line of credit. Closed lines of credit are often used for home construction. Here’s what you need to know about how a closed-end line of credit works.

Key points to remember

  • A line of credit is a type of loan on which borrowers can withdraw money over time, rather than all at once.
  • There are two basic types of credit lines: closed lines of credit and open lines of credit.
  • A closed line of credit must be repaid at a pre-determined time, while an open line of credit has no fixed maturity date.
  • Closed lines of credit are often used in home construction, after which the home owner will refinance with a regular mortgage.

What is a closed line of credit?

A line of credit is a type of loan that allows borrowers to withdraw money as needed, up to a certain predetermined limit. Lines of credit can be open-ended or closed.

The credit lines opened have no fixed maturity when they must be repaid. (That’s why they’re called open-end.) Credit cards are a familiar example. With a typical revolving credit card, the lender gives you a credit limit that you cannot exceed, which is based on your credit score and other factors. As you load purchases onto your card, the amount of credit you have on the card decreases. When you pay your monthly credit card bill, your available credit increases. This can continue for as long as you hold this card.

Reverse mortgages for homeowners age 62 and older can also be structured as open-ended lines of credit. The lender sets a credit limit based on the value of the home and the age of the borrower, which the borrower can draw on if needed. There is no fixed end point, but the loan generally must be repaid after the borrower dies or moves. The borrower may also have the option of making repayments while still in the house, which will replenish their line of credit, much like a revolving credit card.

Most home equity lines of credit (HELOCs) also offer revolving credit, although usually for a fixed period. One type, the fixed rate HELOC, combines features of open and closed lines of credit.

Unlike open lines of credit, closed lines of credit have a fixed end point. You can borrow up to the credit limit, but you must pay off your balance in full when the loan ends. Typically, the line of credit has a drawdown period, during which you can make a series of withdrawals, followed by a repayment period, when you need to start repaying it. Some closed lines of credit only require interest payments during the drawdown period. If you wish, you can also pay off part of your balance before the repayment period, but unlike an open line of credit, this will not increase your available credit.

Closed lines of credit can have different terms and tend to be relatively short. A typical construction loan, for example, might need to be repaid after six months or a year.

Important

Although you can make regular interest payments on a closed-end line of credit, they won’t reduce the amount of principal you owe when the loan matures.

How a closed line of credit works

Suppose you are about to start building a new house for your family. To finance it, you request a closed line of credit for a period of 6 months. The lender may offer you a line of credit equal to 80% of your expected construction costs.

Since you won’t need the money all at once, but will be paying the contractor at various points in the project, you can draw down the line of credit in a series of predetermined steps (like pouring of the foundation) or, in some cases, at regular intervals. You don’t have to repay the loan until the house is finished, but you will likely have to pay interest each month.

When the house is finished, you will have to repay the line of credit. One way to do this is to take out a regular mortgage, using the new home as collateral. Some lenders offer construction-to-permanent loans, which combine the two loans into one application process and one closing. Otherwise, you will have to apply for the two loans separately and at different times. This could be a problem if, for example, your financial situation worsens by the time you’re ready to apply for the mortgage, making you less likely to qualify.

What is a fixed capital loan?

A closed loan is a loan in which the borrower receives a sum of money which he must repay on a certain date, often in monthly instalments. Home loans and car loans are two common examples. Mortgages often have to be paid off in 15, 20 or 30 years, car loans in 24, 36 or 72 months, although there are many different options. Generally, the longer the loan, the lower the monthly payment, although the borrower may pay more total interest over time.

How is a closed line of credit different from a closed loan?

In the typical closed-end loan, the borrower receives a sum of money up front. In contrast, in a closed line of credit, the borrower can withdraw money in a series of withdrawals over a period of time, up to the limit of the line of credit. Closed lines of credit may also require interest payments from the borrower, but not principal repayments, until the full loan matures.

Is interest on a closed line of credit tax deductible?

It depends on how you use the money. For example, you may qualify for a mortgage interest deduction if you are building a house. According to the IRS, “You can treat a home under construction as a qualifying home for up to 24 months, but only if it becomes your qualifying home by the time it is ready for occupancy. The 24-month period can start at any time during the day or after the start of construction.

The essential

A closed-end line of credit can be useful for some purposes, such as when you need to borrow money for an expensive project, like building a house, but don’t need it all. money at the same time. Unlike open lines of credit, closed lines of credit must be fully repaid at some point, which is important to consider before entering into one.

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