What Is a Credit Line?

Claw grabbing at bundles of one dollar bills
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A credit line is a pool of money available for borrowing. Also known as a line of credit, these loans have a maximum limit, and borrowers have the option of borrowing up to that limit (or nothing at all).

Credit lines are used by individuals, businesses, governments, and other organizations. Whenever flexibility is important – the ability to borrow quickly, in an amount that cannot be predicted – this type of loan is helpful.

How do Credit Lines Work?

A credit line is a loan, but it is different from most standard loans.

Borrow when convenient: Once approved, you can generally borrow whenever you need to, and you don’t need to take the money immediately after approval.

Borrow only as much as you need: With a credit line, you have a maximum borrowing limit. As long as you have not yet borrowed the maximum, you can continue to get money – it’s not a one-time thing. You can borrow a little bit today, and borrow more tomorrow if needed.

Contrast a credit line with a standard loan like an auto loan or home loan. With those loans, you only borrow once – when the loan is granted – and you borrow all of the money that your loan allows up front. There’s no option to come back for more money (you’ll have to apply for a new loan).

Repayment is also different: with standard loans, you generally make a fixed monthly payment scheduled to last for a specific period of time (for example, a 15-year mortgage or a 5-year auto loan).

With a credit line, you need to make minimum payments, but you can borrow and repay repeatedly. Eventually, some credit lines require you to stop borrowing and repay your debt with standard amortizing payments that eliminate the debt over several years.

A credit card is an example of a basic credit line.

You start with a zero balance and spend with the card only when you need to. You pay interest on the amunt you’re borrowing, and you can always pay off the loan and start borrowing again within the same month.

Using a Line of Credit

Credit lines are attractive because they’re flexible. You don’t have to apply for a new loan every time you need money. If you expect to borrow multiple times throughout the year, this might be the easiest option. Credit lines are best for cash-flow management when expenses are unpredictable. They can even be attached to checking accounts to prevent overdraft charges.

To spend from your credit line, you’ll often get a checkbook (or a payment card) that draws from your pool of available funds.

Interest charges start once you’ve started borrowing. That’s good news if you’re not using your credit line (or if you pay off any debt quickly). This is another advantage over standard loans: you can pay off your debt today and borrow again in a few months as needed.

Safety net: Lines of credit are best used as a safety net to avoid cash flow issues – they're not the best tool for everyday use or for long-term borrowing. You might have to pay a fee every time you draw on your credit line, and you might find that interest rates are higher than you'd pay for less flexible loans (like standard mortgage or auto loans with fixed monthly payments).

A credit card is an example of a basic credit line. You start with a zero balance and spend with the card only when you need to. You pay interest on the amount you’re borrowing, and you can always pay off the loan and start borrowing again within the same month.

How to Get a Line of Credit

To get a line of credit, you’ll need to apply, just like you’d apply for any other loan. Lenders will decide whether or not to approve your application (as well as how much to offer) based on typical lending criteria:

  • Any assets you pledge as collateral

Collateral is any asset that you agree to give up if you fail to repay the loan according to your lender’s terms. It's not uncommon to use your home as collateral for a home equity line of credit. Borrowing against a home allows you to get approved for large lines of credit at attractive interest rates. However, there’s a risk: you might lose your home in foreclosure if you can’t make the payments.

Business owners might find that lenders demand collateral – especially personal assets like the home you live in – to get business lines of credit. It’s better to use business assets like property, equipment, or vehicles, but many businesses don’t have those types of assets. Learn more about making and avoiding personal guarantees.

You might be able to use cash as collateral instead of pledging an asset such as your home or your car. Money in savings accounts and certificates of deposit (CDs) can secure the loan, assuming you borrow from the same bank that holds your savings. This allows you to continue earning interest in those accounts and avoid putting your house on the line. Of course, that only holds true when your loan balance is zero, so it works out best for infrequent borrowing – if you’re paying interest on your credit line, you’re probably paying more than you’ll earn on savings.

It’s also possible to get a line of credit without using collateral. However, it is more difficult to get approved, and you’ll borrow at higher interest rates because the bank is taking more risk when you get an unsecured loan. Again, credit cards are a classic example: they often have high rates, but you don’t need collateral.

Disappearing Credit Lines

Unfortunately, you can't always depend on your line of credit being there when you need it. Banks typically reserve the right to cancel your line of credit or lower your borrowing limit at any time (and that doesn’t seem to happen when it's convenient for you). That makes credit lines especially tricky: you want them to be there "just in case," but you need to be prepared for the possibility that your bank will pull the plug at a bad time.

As a result, it’s essential to keep an emergency reserve available. The credit line is good for keeping things going and avoiding cash flow crunches or credit card debt, but you need to change course if your lender makes changes.