What Is a Credit Line?

Definition & Examples of a Credit Line

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A credit line is a type of loan that allows an individual or business to borrow money and repay it, often on a revolving basis without applying for a new loan.

Learn about the different types of credit lines and how they work.

What Is a Credit Line?

A credit line, also known as a line of credit (LOC), is a type of standing loan that allows individuals, businesses, or other organizations to borrow cash when they need it, repay what they have borrowed, and continue borrowing without applying for a new loan.

A credit line can come in various forms, including a credit card, home equity line of credit (HELOC), or a small business credit line.

These loans often make it possible to complete projects or do business when you don't have the necessary cash on hand. But they can also be risky. Any time you take on debt and delay paying it back, you're assuming you'll be able to meet your obligation later.

Alternate name: Line of credit (LOC)

How Does a Credit Line Work?

A line of credit is different from a traditional loan. With the latter, you apply for a sum of money and pay it back in installments within that set time frame. You can't continually take out new money against the same loan.

With a credit line, however, you are applying for regular access to cash when you need it. It's usually understood that you may take out money repeatedly throughout the life of your loan.

Secured and Unsecured Credit

Like other loans, credit lines can be secured or unsecured. With a secured loan, your lender requires you to use a personal asset (or assets) as collateral that the bank can seize if you default. A home equity line of credit is a common type of secured credit line. Your HELOC lender will have a claim to that portion of your home's equity if you default on your loan.

A credit card, on the other hand, is an example of an unsecured credit line. Instead of requiring an asset as collateral, your card issuer grants you access to funds based on your financial situation and credit history. If you become delinquent on payments, the credit card company can send your account to collections, but it can't go after any of your tangible property without taking you to court. 

Because secured loans represent a lower risk for your lender, they usually have a lower interest rate than unsecured loans.

Revolving vs. Non-Revolving Lines of Credit

Most lines of credit are revolving or open-end accounts that allow you to continually draw money up to the limit as long as you are making payments according to your account terms.

Some are non-revolving, or closed-end accounts, however. In that case, once you have paid back the balance, you cannot continue drawing funds. A HELOC may work this way once you enter the repayment period, after which you can no longer draw new funds.

Types of Credit Lines

Credit lines can come in several forms, all of which serve different purposes.

With a more traditional line of credit, you might actually have a defined draw period, during which you can repeatedly draw money up to the limit and make interest-only or interest-plus-principal payments. Once you enter the repayment period, however, your balance is due according to the repayment schedule you agreed to with your lender.

A traditional line of credit may be given to an individual or to a business. Other credit lines include:

  • Credit cards: A personal account with a set balance limit for open-ended, revolving consumer spending. Any charges that are not paid off at the end of the month begin to accrue interest payments.
  • Home equity line of credit (HELOC): A line of credit that uses your home equity as leverage to pay for renovations to your home. HELOCs can sometimes be used for other spending as well.
  • Business credit lines: A line of credit with a bank or other lender that a business can use to cover major expenses or operating costs

The best line of credit for you will depend on factors such as your personal or business credit rating, what you have available (and want to) put forth as collateral, and the reason for your loan.

Pros and Cons of Credit Lines

Pros
  • Immediate access to cash

  • Only borrow what you need

  • Interest-only payments during draw period (if applicable)

  • Continue borrowing as needed

Cons
  • Higher interest rates

  • Interest adds up

  • Can put assets at risk

  • Financial risks

  • Unexpected changes

Pros Explained

  • Immediate access to cash: Businesses and individuals can access flexible cash when they need it. A personal credit line can be helpful for something simple such as checking account overdraft protection.
  • Borrow what you need: You don't have to borrow the entire amount allowed. Instead, you can borrow only on an as-needed basis.
  • Interest-only payments during draw period: If you have a loan with a draw period, you can finance major projects without having to worry that you need to start paying everything back next month. This can be a great option for financing a home remodel right before you put it on the market, for example.
  • Continue borrowing as needed: Rather than having a one-time loan and then applying for another one when that one is done, you can continue borrowing and repaying when you need access to more cash.

Cons Explained

  • Higher interest rates: A credit line will often have a much higher interest rate than a traditional loan.
  • Interest adds up: If you are not paying off the principal of your loan, the interest payments will continue to add up. You may end up paying far more than the original amount you borrowed.
  • Can put assets at risk: A secured line of credit, such as a HELOC, can put your assets at risk if you default. Lenders can seize your property, business assets, home, or other collateral.
  • Financial risks: Like any kind of borrowing, credit lines pose financial risks. If you rely on them without being able to pay back the money you borrow, you may find yourself in significant debt.
  • Unexpected changes: The bank issuing your line of credit can decide to cancel your LOC, lower your limit, or change your rate at any time.

Credit Line vs. Credit Limit

A credit line is a name for a type of loan that allows you to borrow and repay money, usually on a revolving basis, such as a HELOC or a credit card.

A credit limit, by contrast, is a feature of a loan. The credit limit of a loan is the maximum amount you can borrow or use at a time before you must begin repaying. For example, if your credit card has a credit limit of $10,000, the charges you make cannot total more than $10,000.

Once you reach that limit, you must begin paying off your credit card balance before you can use it to make additional purchases.

How to Get a Line of Credit

To obtain a line of credit, you must apply as you would with any other loan. Lenders will decide whether to approve your application and determine your borrowing limits based on your:

  • Borrowing history
  • Credit score
  • Available income to repay the loan
  • Assets available as collateral

Before you take out a line of credit for yourself or your business, research the best rate and terms available. That means making sure your credit rating is as strong as possible, eliminating other financial many other obligations, and, if you're a business, ensuring that you're on good terms with vendors.

Once you have a credit line, don't treat it like a cash lifeline you can tap whenever you want. You might receive a checkbook or a payment card that draws from your pool of available funds to help you manage your credit line. It is important to manage your interest payments by paying off your balances on time.

A line of credit can be a powerful tool in your financial toolbox. But, as with any other loan, you should use it with care. A loan is never a free pass to avoid financial responsibility. Make sure you can afford to repay your debts before you enter into them.

Key Takeaways

  • A credit line is a type of loan that allows an individual or business to borrow money and repay it.
  • A credit line can come in various forms, including a credit card, home equity line of credit (HELOC), or a small business credit line.
  • Most lines of credit are revolving accounts that allow you to continually draw money up to the limit as long as you are making payments according to your account terms.
  • To obtain a line of credit, you must apply as you would with any other loan. Lenders will decide whether to approve your application based on your borrowing history, credit score, income, and any available collateral.

Article Sources

  1. Consumer Financial Protection Bureau. "Differentiating Between Secured and Unsecured Loans." Accessed May 11, 2020.

  2. Nolo. "What Can Creditors Do If You Don't Pay?" Accessed May 11, 2020.

  3. Federal Trade Commission. "Home Equity Loans and Credit Lines." Accessed May 11, 2020.