What is a Credit Line?

what is a line of credit

By Justin Pritchard. Banking/Loans Expert

Justin Pritchard helps consumers navigate the world of banking.

A credit line is a pool of available money that you can borrow from. It's like an account with money in it, and you can spend that money if you choose to (except you don't really have the money - you're borrowing when you use the money).

What is a Credit Line?

A credit line is money available for you to borrow. Instead of borrowing a specific amount of money and paying it back over time, the bank allows you to borrow any amount you need (up to your credit limit ), whenever you need it. You can borrow a little bit today and come back tomorrow for a little bit more. The concept is similar to a credit card.

Contrast the credit line to a standard loan such as an auto loan. with those loans, you borrow a fixed amount of money all at once (you can't come back for more).

Then, you start repaying the loan more or less immediately with monthly payments. As you make each payment, a portion of the loan is paid off, and you also pay interest costs (in other words, the loan is amortized over time).

With a standard loan. you borrow 100% of the amount you've been approved for. With a credit line, you can borrow 100% of the amount all in one shot, but you don't have to.

What is a Credit Line Good For?

Credit lines are nice because they’re flexible. You don’t have to apply for a new loan every time you need money.

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Instead, you get a credit line that allows you to borrow money as needed.

If you need $1000 for a repair and you have a credit line, you can just write a check against the credit line. Of course, then you'll start paying interest. so you'll want to repay the loan as soon as possible -- but it's nice to have cash available. If it turns out that you never need any money from your credit line,

you simply avoid taking out a loan (and you won't have to pay any interest because you never borrowed anything).

Credit lines are helpful for cash-flow management. They allow you to meet expenses without the hassle of applying for a new loan. They can even be attached to checking accounts to prevent overdraft charges .

Lines of credit are best used as a safety net - they're probably not the best tool for everyday use or for long-term borrowing. You might have to pay a fee every time you draw on your credit line, and you might find that interest rates are higher than you'd pay for more specific loans (like mortgage or auto loans).

Unfortunately, you can't always depend on your line of credit being there when you need it. Banks typically reserve the right to cancel your credit line or lower your borrowing limit at any time (and they generally don't do that when it's convenient for you). That makes credit lines especially tricky: you want them to be there "just in case," but you need to be prepared for the possibility that your bank will pull the plug at a bad time.

Getting a Line of Credit

So how do you get a line of credit? You generally have to apply for one, just as you'd apply for any other loan. Banks will decide whether or not to offer a credit line (and how much to offer) based on your credit, your income, and any asset that you pledge as collateral .

It's not uncommon to use your home as collateral for a home equity line of credit. This approach generally gives you access to a large amount of money at a reasonable interest rate (because the bank can take your home in foreclosure and get their money back if you fail to repay).

If you don't want to (or can't) pledge property as collateral. you can also get unsecured lines of credit. Unfortunately, it's harder to qualify for an unsecured loan because the bank has nothing to go after; you'll need good credit and a steady income to get approved.

Source: banking.about.com

Category: Credit

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