What is a Line of Credit?

What is a Line of Credit?
Fiona Staff4/14/2021

For most American consumers, borrowing money can mean a few different things. Technically, anyone using a credit card is borrowing funds that need to be paid back on a monthly basis, to avoid interest charges and other fees. There is also (link: /learn/articles/the-ultimate-guide-to-personal-loans text: the personal loan), a handy financial tool that allows borrowers to obtain a lump sum and repay the debt in fixed monthly installments.

Another option that consumers may be less aware of is a personal line of credit. Kind of like a credit card/loan hybrid, a line of credit allows borrowers to “draw” from a fund on an as-needed basis and pay back what they owe within the confines of a monthly billing cycle, similar to a credit card.

Interested in exploring line of credit options? With Fiona, users can compare offers from top online providers, fast and easy.SEE OFFERSObtaining a Line of Credit

Typical of any financial product or service, a consumer needs to apply for a personal line of credit. Getting approved, and what rate and credit limit they can obtain, will hinge heavily on the creditworthiness of the applicant. A personal line of credit is most commonly a form of unsecured debt, meaning a borrower will not have to put up any collateral to become approved.

Just like the online lending boom that has made personal loans so popular in the 21st century, a personal line of credit is a lot easier to find now thanks to a wealth of online providers. Instead of traveling to physical banks and credit unions, people can now compare rates for a personal line of credit from the comfort of their own home.

If approved, borrowers can easily transfer the funds directly into a linked online checking account, while some providers offer debit cards or checkbooks. Borrowers can usually draw from their line of credit as early as the same or next business day.

How a Line of Credit Works

As previously mentioned, a personal line of credit is similar to a credit card in that it is a form of revolving debt. Just like your credit card has a spending limit, a line of credit also has a limit you can draw from. A borrower can redraw multiple times, based on the credit available to them and if their account is in good standing.

Remaining in good standing brings us to how a line of credit is repaid and how the account is managed. Like a credit card, a line of credit generates a billing cycle (typically on a monthly basis) with an account balance that factors the principal amount borrowed plus interest charges. Interest is only charged on the funds a borrower draws from their account, and not the total credit limit.

Each billing cycle statement will include a minimum payment amount, which must be paid by the due date to keep the account in good standing and to avoid penalty fees. If a borrower carries a balance (i.e., does not pay their debt in full), they will incur more interest charges on their next statement, so it’s always best to pay down a balance as much as you can.

Line of Credit Benefits

There are a few reasons a line of credit may attract a consumer in comparison to other lending products. For starters, a line of credit will typically come with a lower interest rate than a credit card (as long as an applicant has good to great credit) and also uses simple interest as opposed to compounding interest (i.e., interest on interest). For these reasons, a line of credit can potentially save a borrower money, when compared to a credit card, even if they are only making the required minimum payment.

Furthermore, a line of credit can be ideal for people with gaps in their income or unpredictable earnings, as it provides a financial safety net in instances when they need to draw funds. It’s often recommended that borrowers use a line of credit for emergency expenses (e.g., medical, auto, home repairs). A line of credit can be used to pay off credit card debt, however, a consumer should explore all options, as they may be able to obtain a better APR with a lump sum, fixed-rate personal loan.

Another benefit of a line of credit is how it can act as a credit builder. If a borrower is not eligible for certain high-end credit cards, or can’t get approved for a certain amount on a personal loan, a line of credit is a way to exhibit good payment habits, as all activity is reported to the major credit bureaus. By keeping a line of credit in good standing, especially if you pay off your monthly balance in full, a consumer can boost their credit rating and increase their future lending options.

Bottom Line

Now that we’ve covered the basics of a line of credit, how it differs from other lending products, and how it can be beneficial, it’s important to know that not all credit lines are created equal. A personal line of credit is just one version, as there is also a home equity line of credit (HELOC), which allows someone to borrow against their home, and a business line of credit for business expenses.

Within the personal line of credit industry, there are several distinctions, too. Different providers offer different rates, minimum/maximum credit limits, and fees. For example, while some providers charge annual fees, others may not. Providers also may differ in the length of draw periods (the timeframe a borrower can draw freely from their account) vs. the length of repayment periods (when borrowers can no longer draw, and must pay their remaining balance in full).

While the options will vary, a line of credit can be a useful option for a consumer looking for a pool of funds to draw from, and at a reasonable rate with transparent repayment terms. With Fiona, users can compare various types of loan offers from multiple top providers, to see which option works best for their specific needs.

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