Line of Credit (LOC)

A Line of Credit is a flexible borrowing arrangement where a lender approves a maximum amount you can draw from at any time, and you only pay interest on what you actually use. It is not a lump-sum loan. You draw funds as you need them, repay them, and draw again, up to the credit limit. Think of it as a financial tap you can open and close as your cash flow demands.

Lines of Credit are issued by banks, credit unions, and financial institutions to individuals, businesses, and government entities. The most common types are personal Lines of Credit, home equity lines of credit, and business Lines of Credit.

How a Line of Credit Works in Practice

Every Line of Credit has two time periods that shape how you use and repay it: the draw period and the repayment period. During the draw period, you can borrow any amount up to your credit limit, repay it, and borrow again. Once the draw period ends, you enter the repayment period. You can no longer draw new funds, and you must pay down the remaining balance according to your agreement terms.

Interest accrues only on the outstanding balance, not the total credit limit. If you have a $50,000 Line of Credit and draw $10,000, you pay interest on $10,000, not $50,000. This is what separates a Line of Credit from a term loan, where interest accrues on the full disbursed amount from day one.

Revolving vs. Non-Revolving Lines of Credit

Most Lines of Credit are revolving. As you repay the principal, the available credit replenishes and becomes available again. A credit card works the same way. If you borrow $5,000 and repay $3,000, you have $3,000 available again without reapplying.

Non-revolving Lines of Credit work differently. Once you repay the borrowed amount, the line closes. You cannot draw from it again. This structure functions more like a traditional loan, except you can choose how much to draw at any point during the draw period rather than taking the full amount upfront.

The Four Main Types of Lines of Credit

Each type of Line of Credit is built for a specific purpose. Choosing the wrong type increases your costs and limits your flexibility.

• Personal Line of Credit: An unsecured revolving facility for individual use. Approval depends on your credit score and income. Interest rates are typically variable and higher than secured options.
• Home Equity Line of Credit: A secured facility where your home's equity serves as collateral. Lenders typically allow you to borrow up to 80% of your home's equity. Interest rates are lower than personal Lines of Credit because the lender has a claim on your home if you default.
• Business Line of Credit: Issued to companies for operational expenses like payroll, inventory, or bridging short-term cash flow gaps. Can be secured by business assets or unsecured, depending on the lender and the business's creditworthiness.
• Demand Line of Credit: A less common structure that allows the lender to demand full repayment at any time. Companies and institutions use these more often than individual consumers.

Secured vs. Unsecured Lines of Credit

A secured Line of Credit requires collateral, typically a home, savings account, or business assets. Because the lender can seize the collateral if you default, secured lines carry lower interest rates and higher credit limits.

An unsecured Line of Credit requires no collateral, which shifts more risk to the lender. That higher risk translates into higher interest rates and stricter credit score requirements. Most personal Lines of Credit are unsecured. Most home equity lines of credit are secured.

Costs to Watch For

A Line of Credit carries several potential fees beyond interest charges.

• Origination fee: A one-time cost charged when the Line of Credit is established.
• Annual maintenance fee: A recurring charge to keep the line open, even if you never draw from it.
• Transaction fee: A per-draw fee applied each time you access funds.
• Prepayment penalty: Some lenders charge a fee if you pay off the balance early or close the line within a set period.

Sources

• https://www.capitalone.com/learn-grow/money-management/line-of-credit/
• https://www.experian.com/blogs/ask-experian/what-is-a-line-of-credit/
• https://ecapital.com/financial-term/line-of-credit-loc/