Line Of Credit – What it Is and How It Works

When you need money, you might consider getting a personal loan, which offers a sum of money. However, if you are not sure of how much you need, then you can consider a line of credit. This is a revolving loan that enables you to access money as much as you need, up to a limit.

Line Of Credit - What it Is and How It Works

Lines of credit are backed by underlying assets, which include a mortgage, and they are usually flexible in how they work. With a line of credit, you can borrow up to that limit again as the loan is repaid. You can also use all the credit lines. Homeowners usually use credit lines to fund paying down a monthly balance, home improvements, and consolidating debt.

What is a Line of Credit?

A line of credit is a type of loan that enables you to borrow money up to a specific limit. Unlike the usual loan, which offers you a sum of money at once, this loan gives you the flexibility to borrow only the amount you need and when you need it. It is mostly used for short-term borrowing needs, which include bridging a temporary cash-flow gap and covering unexpected expenses.

It can also be used for longer-term financing, like a home renovation project or financing a small business. In addition, it is a flexible loan from a financial institution or bank. It is also a defined amount of money that you can access and use as you wish. Later, you can repay what you used instantly or over time. The borrower will pay interest by using a line of credit.

The borrowers must be approved by a financial institution, which looks at their credit rating and their relationship with the bank. Lines of credit tend to be much lower than using a credit card; however, they are not common. Furthermore, the interest rate is mostly variable, which means that it can change as the interest rate changes.

How Does It Work?

If you apply for a line of credit, the financial institution will check if you are qualified to get a line of credit or not. The main eligibility requirements are a good credit score and a stable income. After a borrower withdraws money, interest gets accrued. As soon as the borrower starts making repayments, the amount repaid will be added to the line of credit account. After the end of the draw period, the repayment period will begin.

A line of credit is a form of revolving credit that works just like a credit card. You can write a check or even make card payments in any amount that is up to your borrowing limit and make payments in invariable amounts as long as you can meet a monthly minimum requirement. You can pay interest only on the amount that you borrow. Furthermore, as you pay for your loan, your available credit is replenished.

Types Of Lines of Credit

There are mainly two types of lines of credit: unsecured lines of credit and secured lines of credit.


In an unsecured line of credit, the interest rate is higher than in a secured line of credit. The assets of the borrower are not used as collateral, so the possibility of this type of credit and loan repayment is lower. In addition, the interest rate is also high. There are different types of unsecured lines of credit, and they include:

Personal Line of Credit:

This is an unsecured loan. This is a type of revolving credit that enables people to borrow funds on an as-needed basis and up to a pre-approved limit. It works the same way as a credit card; however, it provides lower interest rates and higher credit limits.

With this, borrowers can withdraw funds when they need them, up to the approved credit limit. The interest is only charged on the amount that you initially borrowed, not on the whole credit limit. As soon as the borrowed money is repaid, the credit line will become available for future use.

Business Line of Credit:

This is a type of financing that offers businesses access to a predetermined amount of money that they can draw as much as they need. It works in the same way as a personal loan; however, it is designed especially for business purposes. With a business line of credit, several businesses can borrow money on a need-basis up to the pre-approved credit limit.

The interest is only charged on the amount that you borrowed, and as soon as the funds are repaid, the credit line is available for future use.

Demand Line of Credit:

This type of line of credit is rarely used. With this loan, the lender can call the funds borrowed due at any time. The payback can be interest plus principal or interest only, depending on the terms of the line of credit. It is worth noting that, borrowers are allowed to spend up to the credit limit at any time.

Secured Line of Credit

This is when the rate of interest given by the bank is low because, in this type of loan the bank provides a loan after accepting one of your valuable assets as a security. Furthermore, the income of the borrower is considered along with the credit score to determine the interest rate. There are different types of secured lines of credit, and they include:

Home Equity Line of Credit:

HELOCs are the most common types of secured lines of credit. This is secured by the market value of the home minus the amount owed, which becomes the condition for determining the size of the loan. Usually, the credit limit is equal to 75% or 80% of the market value of the home, excluding the balance owed on the mortgage.

Home Equity Lines of Credit mostly come with a draw period, usually 10 years. During this time, the borrower can access available funds, repay them, and then borrow them again. After the draw period, the loan balance is due. HELOCs usually have closing costs, which include the cost of an appraisal of the property used as collateral.

A CD-Secured Line of Credit

This uses money that you have on deposit in a certificate of deposit as collateral. You can also keep a CD-secured line of credit open for no more than three to five years, as is usual with an unsecured personal loan.

Security-Backed Line of Credit (SBLOC):

This is when the collateral is offered by the borrower’s securities. Usually, an SBLOC enables investors to borrow from 50% to 95% of the worth of assets in their account. Security-backed lines of credit are non-purpose loans, which means that the borrower might not use the money to buy or trade securities. SBLOCs require the borrower to make monthly payments with interest until the loan is repaid.

The above-mentioned are the different types of lines of credit that you can apply for.

How Do I Qualify?

To be eligible for a line of credit, you need to meet the requirements of the lender, which include sufficient income, proving your creditworthiness with a minimum credit score, and other factors. This is just the typical requirement; however, the lender might demand more.

How To Apply

To apply for a line of credit, you need to visit your financial institution and then apply for a line of credit. Then you submit all the documents required. The bank will verify your credit score and the income of the borrower before they approve the request. Then the credit amount is finalized, and the interest rate is determined by the borrower’s credit score, security, and income.


How Much Can I Get a Line of Credit For?

The maximum credit limit that you can get ranges from $1,000 to $50,000. There is also a minimum draw amount. For example, your lender might not enable you to withdraw less than $50 at a time.

It is Worth It?

A line of credit gives you access to money that can be used as needed. You will be charged only interest on the amount that you use.

Does It Impact On My Credit Score?

Yes, it does. A line of credit has an impact on your credit score. If the repayment is paid on time, your credit will increase, and your credit score will improve. However, if you are unable to repay this loan, then your credit score will drop.