Learn These Basics Before Getting a Line of Credit

When people are in need of money, the last thing that comes to mind is to apply for a line of credit.


Going to a bank for a standard fixed- or variable-rate loan, using credit cards, borrowing from friends or family, or turning to specialist peer-to-peer or social lending or donation sites on the internet are the first things that come to mind. Pawnshops and payday lenders are available in the most desperate of circumstances.

For years, credit lines have been used by businesses to cover working capital needs or take advantage of strategic investment opportunities. Still, they have yet to catch on with individuals. Some of this may be related to banks rarely promoting credit lines and potential borrowers not bothering to inquire. A home equity line of credit, or HELOC, is the only credit line borrowing that may arise. However, that is a loan secured by the borrower’s property, which has its own set of concerns and risks.

So, here are some fundamentals of credit lines.

What Is a Line of Credit?

A bank or financial institution’s line of credit is a flexible loan. A line of credit is a defined amount of money that you can borrow as needed and then repay immediately or over a predetermined length of time, similar to a credit card that offers you a limited amount of funds—funds that you can use when, if, and how you please. A line of credit, like a loan, will charge interest as soon as money is borrowed, and borrowers must be approved by the bank, with such approval being a result of the borrower’s credit rating or relationship with the bank. It is important to note that interest rates are often changeable, making it difficult to forecast how much money you will end up paying back.


When a Line of Credit Is Useful

In brief, lines of credit can be helpful in situations where there will be frequent financial outlays but the amounts are unknown ahead of time or the suppliers do not accept credit cards, as well as instances requiring significant cash deposits—weddings, are a notable example. Similarly, during the housing boom, lines of credit were frequently used to support house improvement or refurbishment projects. For example, people would typically seek a mortgage to purchase a home and a line of credit to assist fund any upgrades or repairs required.