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News Every Day |

What is a line of credit? It's a loan that operates like a credit card with a few restrictions.

Insider's experts choose the best products and services to help make smart decisions with your money (here’s how). In some cases, we receive a commission from our our partners, however, our opinions are our own. Terms apply to offers listed on this page.

  • A credit line is a flexible funding option you can use if you need revolving access to cash, such as if you're renovating your home.
  • You can get a credit line at a financial institution, and your credit score will determine how much you qualify for.
  • HELOCs are the most common type of credit line, but you can also take out personal or business lines of credit.
woman is at the bank talking to a customer service representative
A credit card is one type of credit line, but there are other types such as HELOCs.

When you're borrowing money, it's good to shop around for the best option. For large purchases, you may look for a personal loan. For smaller, everyday purchases, you might want some more flexibility in how you spend and how you pay them off. For that, it might be worth your time to look into a line of credit. 

What is a line of credit?

A line of credit, also known as a credit line, is a type of revolving credit. It's an amount of money extended to you by a financial institution, such as a bank, that you can draw from when you need it. 

A credit line differs from a loan because you can draw upon any amount up to the limit at any time, instead of receiving a lump sum amount that you gradually pay off as you would with a loan. So if you have a $10,000 credit line, you can draw upon $5,000 for a new home repair project when you need it, while still having $5,000 left on your line of credit. If you pay off the money you borrowed, your limit will go back up to $10,000.

There are several ways you can access your line of credit funds. Some lenders will give their borrowers special checks that will draw from their line of credit once they're cashed. Some lines of credit will require borrowers to manually transfer money from their line of credit into their bank accounts. Others simply give you a card to use, exactly like a credit card. Once you draw from the funds available to you, you'll start accruing interest on the borrowed amount.

As you pay back what you borrowed, your available credit will increase, similar to a credit card. A line of credit can offer more flexibility in the amount you borrow and what you have access to, compared to a traditional installment loan.

Line of credit vs. credit card

All credit cards are lines of credit; however, not all lines of credit are credit cards. 

Lines of credit and credit cards differ in how much you'll be paying and how much you'll be getting in return. Credit cards generally have higher APRs than lines of credit, which means you'll be paying more to use a credit card than a line of credit. However, depending on the card, you can also earn points or other perks when you use a credit card.

That said, lines of credit also tend to have higher credit limits, so you can use more before worrying about how it will affect your credit utilization ratio.

Another key difference between the two comes down to flexibility. While lines of credit offer more freedom than a personal loan, they're still more rigid than credit cards. This is because lines of credit have a time limit in which you can borrow money, also called a draw period. These will differ based on the type of credit line you choose, but you'll have a few years to borrow money. You'll still have to make minimum payments during your draw period, but these will be pretty small, usually enough to cover any interest that accrues. 

Once the draw period ends, the credit line will enter a repayment period. In this period, your remaining balance on the line of credit turns into an amortized loan that you'll start paying off. You will also no longer be able to borrow additional money through that credit line.

Types of credit lines

There are various types of credit lines that you may be eligible for, including secured and unsecured credit lines. Secured credit lines are backed by an asset, such as a car or home, which serves as collateral. Some banks that offer brokerage services may also allow you to use your investments as collateral. On the other hand, unsecured credit lines aren't backed by any collateral, e.g. most credit cards.

Home equity line of credit (HELOC)

One popular line of credit is a home equity line of credit, more commonly known as a HELOC. Using a HELOC, homeowners can borrow funds against the equity from the home, meaning the amount of the home's value that you own. If you're still paying a mortgage, you will be able to borrow from what you've already paid off.

HELOCs usually have a draw period of 10 years, at which point you enter the repayment period; some HELOCs require you to settle your debts at the end of the draw period. Some HELOCs will require you to take out a minimum amount upfront.

As a secured credit line, your home's value is used as collateral, you won't need as high of a credit score for these loans. You'll usually be able to borrow up to 85% of your home's equity. 

Personal line of credit

Other types of unsecured lines of credit, such as some personal lines of credit, don't have any assets to serve as collateral but may have fees, though there may be an annual fee or upfront costs to access the line of credit. You might want to use one to pay for school expenses or car maintenance costs, or to fund a business-related project — so long as you know you can repay the loan, that is.

Draw periods on personal lines of credit are typically shorter than the draw periods on HELOCs.

Business line of credit

Like other lines of credit, a business line of credit offers greater flexibility than its loan counterpart. A small business loan will give a business owner a lump sum of money that they'll have to pay off gradually. Meanwhile, a business line of credit will allow business owners to pay for expenses as they arise. Keep in mind that a business line of credit will also be more expensive than a business loan. 

How to get a line of credit

Getting a line of credit is relatively simple. You go to your bank of choice and apply for one. However, there are several things you should consider during the process.

1. Check your credit reports

Before applying for a credit line with a bank, you want to know where you stand credit-wise. You can check your credit report at AnnualCreditReport.com. The information in your credit report is used to create your credit score, so you want to make sure everything looks correct. If there are errors, you can dispute them.

You can also check your credit score on Credit Karma to see how strong your credit is. Your credit score shows a lender how creditworthy you are and can determine the amount of your credit line. You may also be able to check your credit score through a bank or other financial institution you're a member of. 

2. Shop around 

Once you are aware of your credit score, you can apply for a line of credit at a financial institution, such as a bank or credit union. You'll want to shop around for the best rates and check out any limits and eligibility requirements, specifically around your credit score. You typically want a credit score of 670 or higher when you start applying for an unsecured personal line of credit. You may be able to get a line of credit for several thousand dollars up to $100,000 if your credit score qualifies you for it.

In particular, you will want to focus on the terms of your agreement. Of course, you'll want to look at the kind of APR you're eligible for as well as your credit limit. You will also want to look at how long your draw period is and how you will be expected to pay after it ends. Some plans have you paying it all back at the end of the draw period, also called a balloon payment, which changes how you borrow. Some plans will also require that you borrow a certain amount from your credit line upfront. 

3. Apply for a credit line

After checking your credit, you can apply for a credit line. When reviewing your application, a lender will pull a hard inquiry on your credit, giving them access to your credit history. This will show up on your credit report and will lower your score. Once approved, the financial institution will approve you for a specific amount and have a draw period in which you can use money from your credit line. The draw period can vary but may last up to several years.

After borrowing from the credit line, interest will start to accrue and you'll begin to make payments. As you pay back the credit line, your available credit from your credit line will increase.

4. Use your line of credit

Once you have your line of credit, you can start borrowing according to the rules established by your lender. Depending on the credit line you choose, you may have to take out a minimum payment upfront.

Keep in mind the terms you agreed to when you signed off on your credit line. Most lenders don't have restrictions on what you spend your money on. Regardless, you shouldn't be spending too freely, especially if you'll have a balloon payment waiting for you at the end of your draw period.

Read the original article on Business Insider
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