A line of credit (LOC) is a set cap on how much you can borrow that can be used at any time. The borrower can get as much money as they need up to the ceiling. If you have an open line of credit, you can borrow money as you pay it back.
A LOC is an agreement between a customer and a financial company, usually a bank, that says how much the customer can take. The borrower can get money from the LOC whenever they want, as long as they don’t go over the maximum amount (called the “credit limit”) that was set in the deal.
KEY TAKEAWAYS
A line of credit (LOC) is a set amount of money that can be borrowed at any time while the line of credit is still open.
There are many different kinds of credit lines, such as personal, business, and home equity.
The major benefit of a LOC is that it gives you a lot of freedom.
High-interest rates, fees for late payments, and the chance of overspending are all things that could go wrong.
How Credit Lines Work
Learning About Credit Lines
LOCs all have a fixed amount of money that can be borrowed, paid back, and borrowed again as needed. The lender decides the amount of interest, the size of the payments, and any other rules. Some LOCs let you write checks, while others give you a credit or debit card. A line of credit can be protected (with security) or unsecured. Unsecured LOCs usually have higher interest rates because they don’t have anything to back them up.
The LOC is very useful because it has built-in freedom. People who want to borrow money can ask for a certain amount, but they don’t have to use it all. Instead, they can spend the LOC money in a way that fits their needs and only pay interest on the amount they use, not on the whole credit line. Borrowers can also change the amount they pay back depending on their budget or cash flow. They can, for example, pay off the whole amount at once or just make the minimum payment each month.
LOCs can be protected or not
Most LOCs are unprotected loans. This means that the borrower doesn’t have to give the loan anything as security for the LOC. A home equity line of credit (HELOC), which is backed by the borrower’s home equity, is a unique exception. From the lender’s point of view, guaranteed LOCs are appealing because they give the lender a way to get the money back if the borrower doesn’t pay.
Secured lines of credit are appealing to people and business owners because they usually have a higher maximum credit amount and much lower interest rates than unprotected lines of credit. Unsecured LOCs are also harder to get because you usually need a higher credit score or credit rating. Lenders try to make up for the higher risk by putting limits on how much money can be taken and charging higher interest rates. The yearly percentage rate (APR) on credit cards is so high in part because of this.
Technically, credit cards are unsecured lines of credit, and the credit limit, or how much you can charge on the card, is its cap. But when you open a card account, you don’t have to give up anything. If you start missing payments, the credit card company can’t take anything from you to make up for it.
Your credit score can change a lot because of a line of credit. In general, your credit score will go down if you use more than 30% of the amount you can borrow.
Lines of Credit: Revolving vs. Non-Revolving
People often think of a LOC as a type of rolling account, which is also called an open-end credit account. This plan lets people borrow money, spend it, pay it back, and spend it again in a loop that seems to never end. Installment loans, like mortgages and car loans, are different from things like credit cards and lines of credit.
Installment loans let people take a set amount of money and pay it back over time in equal monthly payments. When a person pays off a monthly loan, they can’t use the money again unless they get a new loan.
Non-rolling LOCs are the same as revolving credit (or revolving LOC) in terms of how they work. A credit ceiling is set, and the money can be used for many different things. Interest is usually charged, and payments can be made at any time. One big difference is that the pool of available credit does not grow when payments are made. When you pay off the loan in full, the account is closed and can’t be used again.
Banks sometimes offer personal LOCs in the form of an overdraft security plan as an example. A checking account can be tied to a credit plan if a customer signs up for it. If a customer spends more than they have in their bank account, an overdraft protects them from having a check bounce or a purchase be rejected. An overdraft must be paid back, with interest, just like any other loan.
Types of Lines of Credit There are different kinds of lines of credit, and each one is either protected or unsecured. Aside from that, each kind of LOC has its own features.
Line of Credit for Yourself
This gives you access to funds that you can borrow, payback, and borrow again. To get a personal LOC, you generally need to have a credit background with no missed payments, a credit score of 670 or higher, and a steady source of income. Having funds and stocks or certificates of deposit (CDs) as security helps, but it is not needed for a personal line of credit (LOC).
Personal lines of credit are used for emergencies, weddings, and other events, safety against overdrafts, travel, and entertainment, and to help people with irregular income smooth out bumps.
HELOC stands for Home Equity Line of Credit
Most people use HELOCs, which are a type of protected LOC. The size of a HELOC is based on the difference between the market value of the home and the amount still owed on it. Most of the time, the credit limit is equal to 75% or 80% of the home’s market value minus the amount still owing on the mortgage.
HELOCs usually have a “draw period” of 10 years, during which the user can take out money, pay it back, and then borrow again. After the draw period, the balance is due or a loan is given to pay off the amount over time. Most HELOCs have closing costs, which can include the cost of an assessment of the property that is used as security.
Since the Tax Cuts and Jobs Act of 2017, you can only subtract the interest you pay on a home equity line of credit (HELOC) if the money is used to “buy, build, or substantially improve” the property that the HELOC is secured by.
Line of Credit for a Business
Businesses use these instead of a set loan to borrow money when they need it. The financial company that gives the LOC looks at how much the business is worth on the market, how profitable it is, and how much risk it is willing to take. Depending on the size of the loan and the results of the review, the LOC may or may not be guaranteed. The interest rate changes, as it does with almost all LOCs.
Need a credit line
This type can be either locked or open, but it isn’t used very often. When you have a demand LOC, the loan can ask for the money back at any time. Until the loan is called, the LOC can be paid back in two ways: interest only or interest plus the balance. The user can always spend as much as the credit limit.
SBLOC is short for “Securities-Backed Line of Credit.”
This is a special secured-demand LOC in which the borrower’s assets are used as protection. Most of the time, an SBLOC lets the owner borrow between 50% and 95% of the value of their assets. SBLOCs are loans with no specific aim, which means the user can’t use the money to buy or sell stocks. You can spend money on almost anything else.
SBLOCs require the user to pay only the interest each month until the loan is paid off in full or the stockbroker or bank requests payment, which can happen if the value of the investor’s portfolio goes below the amount of the LOC.
There are limits to lines of credit.
The best thing about a line of credit is that you can take only what you need and don’t have to pay interest on a big loan. Still, people who take out a LOC should be aware of the issues that could come up.
The interest rates and credit standards for unsecured LOCs are higher than those for those with assets.
Most of the time, interest rates on LOCs change, and they vary a lot from one company to the next.
LOCs don’t have the same protections from the government as credit cards. If you don’t pay on time or go over the LOC limit, you may have to pay a lot. An open LOC can make it easy to spend more than you have, which can leave you unable to make payments.
A borrower’s credit score can go down if they abuse a line of credit. Depending on how bad the problem is, it might be a good idea to hire a top credit repair company.
What are some popular types of lines of credit (LOCs)?
Personal, business, and home equity lines of credit (HELOCs) are the most popular kinds of lines of credit (LOCs). Most personal lines of credit are unsecured, while business lines of credit can be either protected or unsecured. HELOCs are backed by the value of your home on the market.
What can I do with a LOC?
LOCs can be used for many things. Paying for a wedding, a trip, or a sudden financial disaster are all examples.
What does a line of credit do to my credit score?
When you ask for a LOC, the lender will check your credit. This causes a hard request to be made on your credit report, which temporarily lowers your credit score. If you borrow more than 30% of the total amount you can borrow, your credit score will also go down.
