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What is a Line of Credit?

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  • Written By: Michael Pollick
  • Edited By: Lindsay D.
  • Last Modified Date: 26 September 2016
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A line of credit (also called a credit line or credit limit) is the maximum amount of money a bank will lend to an individual or business without requiring additional approval. The lender determines this amount based largely on the individual's credit worthiness and income potential. Certain large corporations and high-profile public figures have such a substantial line of credit that they can literally borrow money against it for a lifetime.

Having a line of credit is very useful for small business owners who may have to take out several loans over time to purchase equipment or upgrade their facilities. Instead of applying for one $25,000 US Dollar (USD) bank loan, for example, a business owner with a $25,000 USD line of credit can take out a $5,000 USD loan in April, then a $10,000 USD loan in August and finally a $2,000 USD loan in December, all with prior approval from the lender. By using credit, borrowers can take out just enough money for a specific expense then pay it back entirely before taking out additional funds.

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The amount of interest charged for each smaller loan in a line of credit can be variable. The first loan may have been taken out when lending rates were low, but the second might be affected by an upward or downward change in the prime lending rate or other factors. Banks can also charge penalty fees for late payments on all outstanding loans. Borrowers must keep track of individual loan obligations in order to keep payments on track.

Most people encounter a line of credit when dealing with credit cards or home equity loans. The credit card company establishes an upper limit on charges made by individual cardholders. This credit limit may be adjusted by customer request or by the company itself. Severe financial penalties may be levied on cardholders who borrow more money than their line of credit will allow. Credit cards do allow holders to make several purchases without seeking the approval of the lender.

Home financing options may also include a line of credit based on the value of the borrower's home. This practice is often called a home equity line of credit and is a genuine temptation for cash-strapped homeowners. Similar to a second mortgage, this type of credit establishes a maximum amount of money a homeowner can borrow. In the case of a second mortgage, the bank lends the entire amount of money and the borrower makes regular payments based on the balance due. A line of credit arrangement, however, allows the homeowner to borrow smaller amounts of money to pay off contractors or bills without incurring a large debt up front. Financial experts are divided on the benefits of this form of borrowing, however, so those interested in pursuing a home equity line of credit arrangement should do their homework first.

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anon945431
Post 4

Having a line of credit is very useful for small business owners who may have to take out several loans over time to purchase equipment or upgrade their facilities.

comfyshoes
Post 3

Sneakers 41-I agree with you. I have a line of credit open, but I don’t use it. I keep it open for emergencies in case my personal savings are not enough. It is set at .25% above the prime rate which is currently at 3%.

sneakers41
Post 2

Minouchelle- I am sorry that happened to you. It looks like you had some form of a secured loan arrangement that I am not too familiar with.

I will say that lines of credit are tricky. Many people use lines of credit that they obtained against their home to purchase frivolous things like trips, cars and the like. What most people don’t realize is that a line of credit against a home is considered a recourse loan in which a lien is placed against the property.

This means that even if the borrower completely defaults on the loan and is not able to pay, not only can you lose your home to foreclosure, but the banks can legally force you to repay the amount owed, even after you lose the home. Lines of credit on homes should be used with care and only in emergencies in my opinion.

minouchette
Post 1

I had 3 CD's put into a line of credit, I used about 3/4 of the amount in the lines of credit, now the finance charges are outrageous, how can I get the remaining money out of the credit lines and put into a savings or a CD? The bank says I have to pay back all of the money I used, but it was MY money to start with, it was not a loan.

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