Using a line of credit to pay off debt

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If you're feeling overwhelmed by debt, you may be part of more than one-third of Americans who reported that they’re currently in the most debt of their lives.

Luckily, there are ways to take control of debt and start making real progress toward your goals. One tool that could contribute toward your efforts is a line of credit. When used strategically and responsibly, a line of credit could be a powerful ally in your journey to debt freedom.

Let’s break down how lines of credit could possibly help you pay off debt faster, save on interest charges, and achieve long-term financial stability.

Understanding Lines of Credit

A line of credit is a type of borrowing that allows you to access funds up to a specified credit limit, while traditionally only paying interest on the amount used. Think of it as financial support that can be tapped into when you need it, without having to spend from your hard-earned savings account.

Unlike a traditional loan, which gives you a fixed amount with interest that starts accruing instantly, a line of credit can be more flexible— allowing you to borrow what you need, when you need it, without necessarily needing to reapply each time. The majority of credit lines are also revolving, so as you pay back borrowed funds, that amount may become available to borrow again. 

Types of Lines of Credit

There are several types of lines of credit. The best choice for you will depend on your individual needs and financial situation. 

• Unsecured Lines of Credit: Unsecured lines of credit don't require collateral and are usually based on your creditworthiness. Because of this, these can be hard to qualify for if you have bad credit. They also often have higher interest rates than secured lines of credit.

• Business Lines of Credit: These credit options are usually tailored to small business owners and can provide working capital or funds for business-related expenses. This may be a good option if you need to consolidate debt related to business expenses. 

• Home Equity Loan or HELOC: A HELOC can help pay off credit card debt with lower interest rates and longer repayment periods. If you own a home, you can tap into your home’s equity and withdraw a line of credit, allowing you to consolidate debt or get debt repayment terms that fit your needs. But keep in mind that this could result in the loss of your home if the HELOC is not paid back.

• Other Secured Lines of Credit: Other types of secured lines of credit are backed by collateral, such as savings accounts or money market accounts. Because the collateral lowers lender risk, secured lines of credit often have lower interest rates. Like HELOCs, failure to pay back a secured line of credit could result in loss of your vehicle or other assets that were used for collateral. 

Note: Varo is constantly looking for new and innovative ways to help our customers get ahead with their spending, borrowing, and banking. While our services don’t currently include business lines of credit or HELOCs, our new Varo Line of Credit¹ might be a great option for getting access to an unsecured personal line of credit without interest— rather, pay a simple one-time fee based on each amount borrowed. Looking for a secured credit card option instead? Check out the Varo Believe Credit Builder Card ².

Advantages of Using a Line of Credit to Pay Off Debt

Now let’s get into the main reason you’re here, how a line of credit could help you tackle debt. 

Shift Away for High-Interest Debt

If you have a lower credit score, using a credit card to pay off debt may not be the best choice for you. In fact, many credit cards charge interest rates in the double digits, with the average interest rate for a new credit card being 23.10% in 2024.

Lines of credit, on the other hand, typically offer lower rates than credit cards, especially if the credit line is secured by collateral like a savings account, money market account, or home equity. For example, Bankrate reports that as of June 26, 2024, the average home equity loan interest rate is 8.60%, while the average HELOC interest rate is 9.17%.

Example: 

Let's say you have $5,000 in credit card debt with an interest rate of 18%. If you make a minimum payment of $200 per month, it would take you over 11 years to pay off the balance, and you'd end up paying more than $3,500 in interest. 

Instead, if you used  a line of credit to make that same $200 monthly payment, with a 10% interest rate, could help you pay off the credit card debt in about 2.5 years. In this example, you could save over $2,000 in interest charges.

Increased Flexibility 

With a line of credit, you can borrow what you need, when you need it, then pay back the funds on a more manageable schedule. This can be especially helpful if your income fluctuates or if you are dealing with unexpected expenses. 

Example:

If you're a freelancer with irregular income, a line of credit could help you manage cash flow while still making progress on your debt.

A Financial Cushion

Unexpected expenses happen to everyone. When you get hit with medical bills, car maintenance, or home repairs, having access to emergency funds in these situations could provide peace of mind and help avoid turning to high-interest options like payday loans or unsecured credit cards. However, this financial cushion shouldn’t be seen as an excuse to overspend.

Example:

Imagine you're making steady progress on paying down your debt when your car suddenly breaks down, requiring an expensive repair. According to a study from Carinsurance.org, drivers who own the same car for 8 years, spend an average of $3,400 on car maintenance.

Without an emergency fund, you may be tempted to charge those maintenance expenses on a credit card. But with a reliable line of credit, you could cover the repair cost and repay over time, which could then minimize the impact on your debt repayment plan.

Risks of Using a Line of Credit for Debt Repayment

Paying off debt with a line of credit has pros and cons. While lines of credit can be a powerful tool for paying off debt, it’s important to paint a complete picture so that you can make the best decision for your financial situation. Here are potential drawbacks of credit lines that you should be aware of.

Possible Increased Debt

If lines of credit are not used responsibly, you could actually increase the amount of debt you have. Because lines of credit provide easy access to funds, it can be tempting to borrow more than you need or use the funds for non-essential expenses, leading to a cycle of debt that can be harder to break free from. When using lines of credit for this purpose, it may be important to  stay deliberate and disciplined with this spending.

Potential Loss of Collateral

If you’re using a secured line of credit, the lender will likely want collateral. The most common types of collateral for this purpose are homes or cars. If you're using your home equity as collateral, you could risk foreclosure if you default on the loan, making it even more difficult to qualify for mortgage financing in the future. This may also lead to higher mortgage rates going forward.

Variable Interest Rates

Unlike fixed-rate loans, where the interest rate remains the same throughout the life of the loan, many lines of credit often have variable rates that could fluctuate based on market conditions. This means that even if you qualify for a low rate initially, there's a risk that your rate could increase over the course of repayment, ultimately making the debt more expensive.

Additional Fees

In addition to interest charges, many lines of credit could come with various fees that add up over time. Before opening a line of credit, carefully review the Terms and Conditions to fully understand all the potential costs involved. These may include:

• Annual fees: Some lenders may charge an annual fee simply for having the line of credit available, even if you don't use it.

• Transaction fees: You may be charged a fee each time you withdraw or take an advance from your line of credit.

• Balance transfer fees: If you're using a line of credit to consolidate debt, you may be charged a fee for transferring balances from other accounts.

• Late payment fees: If you miss a payment or pay late, you may be subject to additional fees and/or penalties.

While the risks and drawbacks of using a line of credit for debt repayment are significant, they can be managed with careful planning and a commitment to responsible use. 

Strategies for Effective Debt Reduction with a Line of Credit

If you've decided that a line of credit is the best course of action to repay your existing debt, these strategies may be helpful to keep in mind to help this plan be more effective.

Debt Consolidation

If you have multiple high-interest debts, consolidating them into a single line of credit with a lower rate could simplify repayment and save money on interest over time. It may be helpful to shop around for the best rates and terms to avoid taking on new debt after consolidating when possible.

Create a Repayment Plan

Before borrowing from your line of credit, it may also be important to create a clear repayment plan that outlines how much you'll borrow, how you'll use the funds, and the cadence in which you’ll pay off the balance. When you are diligent with this plan, it can help you avoid falling deeper into debt.

Regular Review and Adjustment

To help your financial situation, it may be helpful to regularly review your debt repayment progress and adjust your strategy when needed. If you find that you're not making the progress you'd like, you may want to consider increasing your payment amounts or exploring other debt repayment options.

How Do Lines of Credit Compare to Other Borrowing Options?

Many people are familiar with credit cards and personal loans, which have similarities to lines of credit, but there are also key differences to keep in mind. Let’s compare.

Credit Cards vs. Lines of Credit

Like lines of credit, credit cards often provide a revolving borrowing limit. However, credit cards often have higher interest rates and/or annual fees. They're also typically used for smaller, everyday purchases rather than larger expenses. 

Some people with multiple credit cards like to consolidate debt by transferring their credit balances onto one card, using what’s called a balance transfer credit card. However, this strategy can lead to higher interest rates and more expenses over time. 

Personal Loans vs. Lines of Credit

When comparing personal loans and personal lines of credit, there are some notable differences to consider. Personal loans usually offer a lump sum of funds which are  repaid in regular installments over a set period— usually with interest rates that are typically lower than credit cards. However, they are usually less flexible than lines of credit and require you to reapply each time you need new funds. Personal loans are often more suitable for one-time expenses and could also be a viable option for debt consolidation.

Note: Varo Line of Credit  gives you the best of both worlds, providing customers with access to a lump sum of cash for a single, one-time fee (similar to a personal loan), while giving you the flexibility to potentially borrow more immediately after repayment, without needing to reapply (similar to a traditional line of credit), assuming your financial situation hasn’t changed.

Is a Line of Credit the Right Choice for You?

Consolidating debts through a line of credit could help simplify repayment and potentially lower your interest rates. But, before taking on new debt, it may be important to carefully consider your financial situation and weigh all the potential risks and benefits. Here are some questions you can ask yourself when deciding whether or not to open a line of credit.

• How much debt do I have, and how quickly can I pay it off with my current financial situation?

• What financial priorities and goals do I have, such as saving for emergencies or investing for retirement?

• How will using a line of credit impact my ability to achieve my financial goals?

Once you've weighed these factors, if a line of credit aligns with your financial goals, then it may be worth exploring Varo Line of Credit¹. When qualified, you could unlock a world of economical solutions tailored to your needs and enjoy a hassle-free borrowing experience with a one-time flat fee, and no interest charges, late fees, or prepayment penalties. Our single-fee payment plan may help be the solution you need to get out from under high-interest debt cycles and start paying back at a flat, predictable rate. 

With Varo Line of Credit, your credit limit may increase up to $2,000 over time with continued banking actions and timely repayments. Repayment options span 3 to 12 months (depending on the amount borrowed). Our hope is that Varo Line of Credit can make borrowing more accessible to everyday people, helping them get ahead.

Get started with Varo today or click to learn more about Varo Line of Credit!

^{1 The Varo Line of Credit is designed to help customers with unforeseen expenses with monthly payments, no late fee, no prepayment penalties, and no interest. To be eligible, your accounts must maintain a positive balance. Minimum monthly deposits, average daily balances, and other eligibility requirements apply. Once qualified for Varo Line of Credit, you will be assigned a credit limit from $600 to $2,000. A one-time fee is added to your borrowed amount, early repayment of your advance does not reduce the one-time fee. Your credit limit may fluctuate from one advance to the next based upon a variety of factors. You may only take one Varo Line of Credit out at a time. Your eligibility information and/or credit limit is always available to you in the home screen of your Varo app. Checking offer eligibility will not impact your credit score. If you are eligible and choose to apply for an offer, we will pull your credit and your credit score may be impacted.}

^{2 Varo Believe is a secured credit card designed to help you build credit; however, a variety of factors impact your credit and not all factors are equally weighted. Building credit may take time and Varo Believe may be able to help when you consistently make on-time payments.}