Definition of a closed end credit line

A closed line of credit combines the characteristics of a closed type of loan with a line of credit. Closed-ended credit lines are often used to build homes. Here’s what you need to know about how a closed credit line works.

Basically Takeaways

  • A line of credit is a type of loan from which borrowers can get money over time, and not all at once.
  • There are two main types of credit lines: closed-ended and open-ended.
  • A closed credit line must be repaid at a predetermined point, while an open type credit line does not have a fixed expiration date.
  • Closed-ended credit lines are often used to build homes, after which the homeowner will refinance with a regular mortgage.

What is a Closed End Credit Line?

A line of credit is a type of loan that allows borrowers to receive money as needed, up to a certain predetermined limit. Credit lines can be either open or closed.

Open credit lines do not have a fixed end point when they have to be repaid. (This is why they are called open-end.) Credit cards are a well-known example. With a standard revolving credit card, the lender gives you a credit line that you can not exceed, which is based on your credit score and other factors. As you top up purchases on your card, the amount of credit you have on your card will decrease. When you pay your monthly credit card bill, your available credit will increase. This can continue for as long as you hold this card.

Reverse mortgages for homeowners aged 62 and over can also be structured as open credit lines. The lender sets a credit limit based on the value of the home and the age of the borrower, which the borrower can then use as needed. There is no fixed end point, but the loan should generally be repaid after the borrower dies or moves out of the home. The borrower may also have the option of making payments while still at home, something that will replenish the credit line, such as a recyclable credit card.

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

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

Closed-ended credit lines can have different terms or lengths and tend to be relatively short. A standard construction loan, for example, may need to be repaid after six months or a year.

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Although you can make regular interest payments on a closed line of credit, they will not reduce the amount of capital you owe when the loan expires.

How a closed end credit line works

Suppose you are about to start building a new home for your family. To finance it, apply for a six-month closed-end credit line. The lender can offer you a credit line equal to 80% of your expected construction costs.

Because you will not need the money at the same time, but you will pay the contractor at various points in the project, you can raise the credit limit in a number of predetermined stages (such as pouring the foundation) or, in some cases, at regular intervals. You do not need to repay the loan until the house is completed, but you will probably be asked to make interest payments each month.

When the house is finished, you will have to repay the credit limit. One way to do this is to take out a regular mortgage using your new home as collateral. Some lenders offer construction to permanent loans, which combine both loans in one application process and in one closing process. Otherwise, you will have to apply for the two loans separately and at different points. This could be a problem if, for example, your financial situation changes for the worse until you are ready to apply for a home equity loan, making it less likely that you will qualify.

What is a closed loan?

A closed loan is a loan in which the borrower receives a sum of money that he has to repay by a certain date, often in monthly installments. Mortgages and car loans are two common examples. Mortgages often have to be repaid in 15, 20 or 30 years, car loans in 24, 36 or 72 months – although there are many different options. Usually, the larger the loan, the lower the monthly payment, although the borrower may pay more interest over time.

How Is A Credit Line Different From A Credit Loan?

In the standard closed loan, the borrower receives a sum of money in advance. In contrast, in a closed line of credit, the borrower can receive money in a series of withdrawals for a period of time, up to the credit limit. Closed-ended credit lines may also require interest payments from the borrower, but no principal repayment, until the loan is completed.

Is interest deductible tax on a closed end credit line?

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

The bottom line

A closed line of credit can be useful for some purposes, such as when you need to borrow money for an expensive project, such as building a house, but you do not need the money at the same time. Unlike open credit lines, closed credit lines have to be repaid in full up to a certain point, which is important to consider before you start.

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