Line of credit
What is a line of credit?
A line of credit, also known as a credit line, is an open-ended, revolving loan that a borrower may access on demand. The lender determines the total amount credit to extend based on the borrower’s creditworthiness, and the borrower can access funds from the line of credit at any time, up to the maximum amount set by the lender.
The main benefit of a line of credit is flexibility. With fixed loans, a borrower receives a lump sum and immediately starts making interest payments on the full balance. With a line of credit, a person may borrow as much or as little of the available credit as needed, and only pays interest and fees on that amount.
Lenders offer secured lines of credit and unsecured lines of credit. A secured line of credit is backed by collateral — such as a vehicle, a home, or another asset — and typically carries a much lower interest rate as it is less risky for the lender. An unsecured line of credit is not backed by collateral and carries a higher interest rate to account for the greater risk.
Credit cards are the most common variety of credit line. The maximum amount of funds available to a credit card holder is known as the credit limit. Card holders can borrow up to their credit limit, repay the funds borrowed, and borrow the amount again. A credit card borrower begins with a relatively low credit limit, but once the borrower establishes a good credit history, the lender will typically increase the credit limit available.
Another common line of credit is a home equity line of credit (HELOC). They are secured credit lines backed by the value of the borrower’s home, and generally carry low interest rates. A HELOC comes with a set period of time during which the borrower can draw on the line of credit. The draw period usually lasts around 10 years before the line of credit will be called in for full payment.
Lines of credit are also extended to business owners. Business credit lines are often used to provide liquidity to businesses waiting on payment for goods sold and services rendered. Funds are used for everyday operations, or to expand the business, buy new inventory, or pay off other debts. A business line of credit is backed by the business’s assets, such as real estate, vehicles, or even office furniture.
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Line of credit example
If a borrower’s line of credit is $10,000 and she doesn’t withdraw any money, she doesn’t have to pay any interest. The entire $10,000 balance, however, is available for eligible purchases at any time. Borrowers only make payments on the money they have actually used. They can either pay the entire amount at once, or choose to make minimum monthly payments.