What Is a Line of Credit?
A line of credit (abbreviated as LOC) works as a pool of credit. That amount is capped by the credit limit. Lines of credit are flexible — you can spend the entire sum at once or only take portions. This can be done an unlimited number of times during the draw period (which can last up to a few years). ¹
LOCs can come in several forms. Credit cards are one example of a revolving line of credit. Overdraft protection pulls funds from your LOC to complete transactions or prevent checks from bouncing when you have insufficient funds.
Your creditworthiness will be an important factor in your LOC pool limit. A better credit score will mean a higher maximum amount of credit. However, a solid rating will also give you lower LOC interest rates.
Personal Line of Credit (PLOC) Basics
A personal line of credit or PLOC allows you to borrow multiple times, up to a preset borrowing limit. If you do hit that limit, you can pay that line of credit and can borrow as needed. These can be convenient because if you need to borrow funds, you won’t have to apply for another loan. Common uses for these loans include home repairs, car repairs, medical bills, and sometimes even everyday expenses like gas or groceries.
How Personal Lines Work
When you’re approved for a personal line of credit, the lender gives you a maximum borrowing limit. You can borrow any amount up to that account’s credit limit at any time during the draw period.
For example, if you have a $5,000 credit limit and borrow $1,500, you would still have $3,500 available to use later. If another unexpected expense comes up, you can draw additional funds without submitting a new loan application, as long as you remain within your limit.
As you repay the amount you borrowed, your available credit increases again.
Many lenders require minimum monthly payments, though you can usually pay more at any time.
With a personal line of credit, interest is typically charged only on the amount you actually borrow, not your full credit limit. Once you repay that balance, interest charges stop accruing on the repaid amount.
Home Equity Line of Credit (HELOC)
A home line of credit or HELOC allows homeowners to borrow from the equity of their home through a credit line. Similar to personal lines of credit, you can borrow as you need up to your credit limit, and make payments if you would like to borrow more. Credit limits for home equity lines of credit will depend on several factors, including:
- The equity you have in your home.
- Your debt-to-income ratio.
- Your credit history and score.
- Your home’s appraised value.
Because the home serves as collateral, HELOCs may offer higher borrowing limits than unsecured credit products. One thing to keep in mind is that most lenders will require appraisals, which may be in-person, automated, or drive-by appraisals, depending on the lender; regardless, an appraisal will play a large role in these loans.
HELOC Interest Rates and Risks
Interest rates for HELCOs are typically variable interest rates, meaning they can change throughout the life of the loan. These changes will depend largely on market conditions. As a borrower, this can mean paying less or more each month, depending on interest rate trends.
It can be helpful to be strategic when interest rates are low, for example, many people choose to refinance during this time.
It’s important to understand that a HELOC is secured by your home. If you fail to make payments, the lender may have the right to begin foreclosure proceedings, which could result in losing your home.
Business Line of Credit
A business line of credit allows business owners to borrow as they need up to their given credit limit. Business owners use lines of credit for all kinds of business-related expenses, including:
- Startup and growing costs
- To pay employees and take care of costs like healthcare
- To purchase the necessary equipment
Many business owners choose to connect their line of credit to a dedicated business bank account to simplify cash flow management and expense tracking. Keeping business borrowing separate from personal finances may help improve budgeting, organize records for accounting purposes, and make repayments easier to manage.
Business Credit Offer and Eligibility
For eligibility, lenders may request company financial statements to better understand the business’s revenue, cash flow, and overall financial health.
Lenders may also review both personal and business credit separately. A business credit check helps show how the company has handled past financial obligations, while a personal credit check may be used to evaluate the owner’s creditworthiness, especially for newer businesses.
Before accepting an offer, business owners should compare lender terms carefully. Important details to review include the credit limit, interest rate, repayment schedule, fees, draw period, and whether the lender requires collateral or a personal guarantee.
Pros and Cons of Lines of Credit
Here are some general advantages and disadvantages of lines of credit that you should be aware of:
Pros:
- The ability to borrow as you need, and no need to fill out another application form if you need to borrow money again.
- Interest only applies to the amount you borrow, which can be advantageous if you only borrow a little.
- Can be useful for emergencies when you are unsure about exactly how much you will need.
- You may be able to save on interest if your rates are variable and rates are trending on the lower end.
Cons:
- There may be additional fees when compared to installment loans.
- Borrowing too often can lead to long-term debt.
- These borrowing options may have more fees when compared to installment loans.
- Essential collateral may be at risk if you cannot pay back your line of credit.
- You may be faced with higher interest rates if market conditions cause a spike.
How to Get a Line of Credit
Here are the typical steps to get a line of credit. Things can be a little more complicated with business lines of credit and HELOCS, but typically, here is what you can expect:
- Prequalify With a Soft Credit Check: The first step is to inquire with lenders; many people turn to credit unions, banks, and online lenders. Inquiring will typically involve a soft credit check, a credit check that won’t impact your credit score.
- Continue with a Full Application: If you qualify to move forward after a soft credit check, you can move forward with the application process, which will typically involve a hard credit check and submission of identification, checking account and other bank details, and income documentation.
- Submit Your Application and Await a Decision: Once you have everything you need sent in, you can submit your application, and a lender will let you know if they need additional information and eventually give you a decision.
- Review The Credit Offer Carefully: If approved, you should go over the terms and conditions of your line of credit carefully before signing and borrowing. From here, you’ll be able to borrow as you need up to your credit limit, and make payments to continue borrowing, as long as your account is open.
Do You Pay Interest On a Line of Credit?
Just like any other loan where you need to borrow money instantly, lines of credit are subject to interest. But, with LOCs interest applies to borrowed sums, not the entire credit pool. You will only pay interest fees on the withdrawn amount.
Lines of credit can be secured and unsecured. Secured LOCs are backed by collateral.² The creditors face less risk when issuing such lines of credit. That’s why you’ll also pay lower interest with a secured LOC. A typical example is a Home equity line of credit (called HELOC), but the most common unsecured LOC product is a credit card.
It is easier to apply for secured lines of credit because of the collateral. To get an unbacked LOC, you’ll want to make sure you have a good credit rating. This will also get you lower fees, as an unsecured line of credit can be expensive. Lines of credit without backing may have a higher APR.
Some financial institutions or credit card companies charge fees other than interest, such as a monthly account maintenance fee, called the unused line fee. By having an account with CreditNinja, you’ll always know which fees you need to pay and why. No unpleasant surprises!
Credit Work: Steps to Improve Eligibility
Your credit score will be a huge factor when it comes to any lending product, and so if your credit score isn’t great at the moment, it’ll be super helpful to help improve it. Here are some steps you can take:
- Review your credit reports regularly and dispute any inaccuracies or outdated information that could negatively affect your score.
- Reduce your credit utilization ratio by paying down credit card balances and avoiding maxing out available credit limits.
- Focus on paying down high-interest balances first, which may help lower overall debt faster and reduce interest costs over time.
- Make all payments on time whenever possible, since payment history is one of the biggest factors affecting credit scores.
- Avoid applying for too many new credit accounts within a short period, as multiple hard inquiries may temporarily lower your score.
Improving your credit score may take time, but responsible borrowing and consistent repayment habits can help build a stronger credit history over the long term.
What Is a Revolving Line of Credit?
Some lines of credit allow the customer to fill the pool of drawable cash back up by repaying used credit. These are called revolving LOCs. Withdrawing $2,300 from your $3,000 LOC will leave you with just $700 of available credit. However, by repaying the borrowed sum of $2,300 plus interest, you will replenish the pool back to $3,000. Overdraft protection can work this way, providing you with immediate access to an unconditional revolving line of credit (which is, appropriately called an “overdraft line of credit”.)
Non-revolving lines of credit don’t have this function. Once you’ve used up a portion of the money, it’s gone for good. Repaying the $2,300, with all expenses, won’t replenish the usable cash — you’ll have $700 left on your line of credit. And once the whole amount is used, the account is closed.
How Can I Repay My Line of Credit Fees?
Most banks or credit issuers will give you a choice on how to repay used credit. Interest only applies to withdrawn sums. With CreditNinja, you can choose which repayment plan works best for you. You can opt to pay only the minimum installments. Stick with whichever plan works best for your personal finances.
Are Lines of Credit Better Than Personal Loans?
LOCs have important advantages over typical loans. By taking a personal loan, you’ll receive the whole principal at once, and interest will accrue on the entire sum. This can prove costly if you don’t need the entire principal. Lines of credit allow you to choose how much you want to borrow, and when you want to do it. Interest will apply only to withdrawn amounts. This way, you can save money in the long run.
In addition, revolving LOCs let you redraw cash as much as you like. With personal loans, once the money is used, there’s no way to replenish it.
Comparing Lines of Credit, Credit Cards, and Personal Loans
Below is an easy-to-read table comparing the most common lines of credit:
| Feature | Line of Credit | Credit Card | Personal Loan |
| How Funds Are Received | Borrow as needed up to a credit limit. | Make purchases or cash advances up to a limit. | Receive a lump-sum payment upfront. |
| Repayment Structure | Flexible repayment with reusable credit. | Revolving balance with minimum monthly payments. | Fixed monthly payments over a set term. |
| Interest Charges | Interest applies only to borrowed amount. | Interest applies to unpaid balances. | Interest applies to the full loan amount |
| Interest Rates | May be variable or fixed depending on lender. | Typically higher variable APRs. | Often fixed interest rates. |
| Flexibility | High flexibility for ongoing or unexpected expenses. | Convenient for everyday purchases. | Best for one-time planned expenses. |
| Credit Limit Reuse | Yes, with revolving lines of credit. | Yes | No, new loan required after payoff. |
| Best Uses | Emergencies, home repairs, cash flow gaps. | Everyday spending, short-term purchases. | Major expenses like debt consolidation or large purchases. |
| Collateral Requirements | May be secured or unsecured. | Usually unsecured. | May be secured or unsecured. |
| Risk Factors | Variable rates may increase payments | High APRs and overspending risk | Less flexible once funds are disbursed |
| Payment Predictability | Payments may vary depending on usage and rates | Payments vary based on balance | Predictable fixed payments |
Why Are Most Personal Lines of Credit Not Secured?
When it comes to finding the right loan or line of credit, one of the main factors to consider is whether to go with a secured or unsecured option. But what is the difference, and what are the pros and cons of each?
When it comes to lines of credit, many of them are unsecured. A home equity line of credit is one of the secured options you may come across. But your standard line of credit is usually unsecured.³
A secured loan or line of credit is one that requires collateral. And collateral is a valuable item or asset that you offer the lender in exchange for the loan. Once you pay back the loan or line of credit you get your collateral back. But if you can’t, or don’t, repay the loan, the lender can keep you line of credit to cover their loss.
Collateral offers a layer of security for the lender. If they have collateral from the borrower, they know they won’t lose all of the money they’ve lent because they can sell the collateral to recover their loss. Unsecured loans on the other hand don’t offer as much security to the lender. And less security can mean higher interest rates.
Secured vs. Unsecured Lines of Credit: How Are the Interest Rates Different?
Unsecured loans tend to carry higher interest rates than secured loans, depending on the type of loan in question. Since the lender is taking a larger risk with an unsecured loan, they may charge more. So. if you’re willing to offer up collateral for your loan or line of credit, it could potentially get you a better interest rate.
You might also find secured loans to be less strict with the approval process. This is because the lender already has an added layer of security with your collateral. Unsecured loans usually require the lender to vet their customers more thoroughly. This is to ensure that anyone they give a loan to is able to repay it in the long run.
FAQ
What is a line of credit?
A line of credit (LOC) is a flexible borrowing option that allows you to access funds up to a set credit limit. Instead of receiving one lump sum, you can borrow only what you need, repay it, and often borrow again as funds become available.
How does a line of credit work?
A line of credit works like a pool of available funds. You can withdraw money as needed during the draw period, repay what you borrow, and continue using available credit as long as your account remains open and in good standing.
Do I pay interest on the full credit limit?
No. In most cases, interest only applies to the amount you actually borrow, not the entire approved credit limit.
What is the difference between a secured and an unsecured line of credit?
A secured line of credit requires collateral, such as a home or savings account. An unsecured line of credit does not require collateral but may have higher interest rates because the lender takes on more risk.
What is a HELOC?
A HELOC, or home equity line of credit, allows homeowners to borrow against the equity in their home. Because the home acts as collateral, HELOCs may offer higher borrowing limits than unsecured credit products.
How can I improve my chances of approval?
You may improve eligibility by:
- Paying bills on time
- Reducing credit card balances
- Lowering your credit utilization ratio
- Reviewing credit reports for inaccuracies
- Paying down high-interest debt
- Line of Credit | Investopedia
- Difference Between Secured Line of Credit & Unsecured Line of Credit | Investopedia
- How Does an Unsecured LOC Work? | The Balance