What Is a Line of Credit? How It Works and When To Use One

A line of credit gives you immediate access to a preset borrowing limit for a certain time. It's typically structured as a revolving loan you can use, repay and reuse as needed, unlike an installment loan, which provides an upfront lump sum you repay over a fixed term. A line of credit is typically best for people who need flexible financing or have ongoing or unpredictable expenses.

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Key Takeaways

• A line of credit is revolving credit. You borrow up to a preset limit, then repay and reuse it during a draw period that usually runs two to 10 years, paying interest only on the amount you actually use.

• You generally need good credit to qualify. Lenders typically look for a FICO score of at least 670, according to myFICO, and may reserve their lowest rates for higher scores.

• Rates are usually variable. APRs on a line of credit can start around 11% and cap near 18%, so your cost can move with benchmark index rates — unlike a fixed-rate personal loan.

• Utilization matters. Using more than 30% of your available credit at any time can hurt your credit score.

• Fees can add up. Beyond interest, you may owe an annual or maintenance fee plus an unused fee, often 0.5% to 1%, on the credit you don't tap.

• It fits flexible or unpredictable costs. A line of credit works best when expenses are unclear or spread over time, like a major home renovation — not one-time purchases with a fixed price tag.

Summary generated by AI, verified by MoneyLion editors

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How Does a Line of Credit Work?

A line of credit is a revolving loan with a preset limit that you can borrow against at any time during a draw period of usually two to 10 years. It works like this:

1. You apply with a lender and receive approval for a set credit limit.

2. You borrow funds as needed.

3. You pay interest on the amount you've used.

4. You repay what you owe and can borrow again, up to your preset limit.

The main types of credit lines include:

• A personal line of credit lets you borrow up to your preset limit for personal expenses. 

• A business line of credit lets businesses or business owners borrow up to their preset limit to cover operating expenses or cash-flow gaps. 

• A home equity line of credit (HELOC) lets a homeowner borrow against their equity, with the house serving as collateral, meaning it could be forfeited if they default.  

Here’s a quick real-world example of how lines of credit work: Say you borrow $10,000 against a $20,000 personal line of credit. Interest starts accruing immediately on that $10,000 at a variable 10.75% annual percentage rate (APR).  

You pay $2,000 back, plus all accrued fees and interest, within your first billing cycle. You now owe $8,000, with fees and interest still accruing, but you now have access to the $12,000 of your credit limit that's not in use.

Note: While less common, some lines of credit are non-revolving, meaning your available credit doesn't replenish if or as you repay the balance.

Line of Credit vs. Personal Loan vs. Credit Card 

A personal loan is an installment loan: You receive funding upfront, then make a fixed monthly payment over the loan's term, usually two to five years. Personal loans generally carry fixed APRs that, unlike lines of credit, won’t change alongside benchmark index rates during your repayment period. The Fed puts the current interest rate on a two-year personal loan at 11.86%. Personal loans are best for funding large, one-time expenses, such as debt consolidation or a medical expense.    

A credit card is a revolving loan that charges a variable APR, like a line of credit. However, credit card rates run higher, averaging around 20.94%, while APRs on lines of credit can start at around 11% or cap at 18%. Unlike lines of credit, most credit cards come with grace periods that let you avoid interest if you repay balances in full by your monthly due date. That's why credit cards are often best to fund everyday purchases that you can pay off quickly. 

Ultimately, a line of credit may trump a personal loan or credit card for funding expenses with unclear costs or long, spread-out stages, like a major home renovation. 

Is a Line of Credit Right for You? 

This checklist can help you decide if a line of credit aligns with your borrower profile or current financial needs. 

Remember, you generally need a good credit score of at least 670, according to myFICO, to qualify for a line of credit, and lenders may reserve their best rates for even higher scores. At a maximum APR of 18% to 21%, borrowing against a line of credit can get pricey. Plus, using more than 30% of your line of credit can negatively impact your credit utilization rate and hurt your credit score.

The other big risk to consider? Because credit limits are generally flexible and "replenishable," you could wind up borrowing more than you can reasonably repay in the short or long term.

How To Get a Line of Credit

Getting a line of credit typically involves these steps:​

1. Check your credit to understand if or what offers you might qualify for, along with whether there are steps you can take to improve your credit score before applying.  

2. Compare lenders to help ensure you get the best possible offer for your credit and financial profile. Some lenders let you prequalify for a line of credit, so you can gauge your approval odds, line sizes, and rate estimates without getting hit with a hard inquiry and damaging your credit score.

3. Gather documentation. Most lenders will ask for a government-issued photo ID, like a passport or driver's license, your Social Security number, proof of income, such as pay stubs or tax returns, and bank statements.

4. Apply formally by completing and submitting a full application online, at a bank branch, or over the phone. Most line of credit applications take anywhere from a few business days to six weeks to process, depending on the type. HELOCs typically take the longest time, since they may require a home appraisal.

5. Review and accept your offer. Beyond your APR type and range, compare draw periods — how long the line of credit is active — draw minimums, maximums or other restrictions, such as whether you need to space out funding requests, and how you access those funds, such as direct deposit or ATM withdrawal. It's also important to check for an annual or maintenance fee, which lenders may charge just for extending the credit, or an unused fee, a percentage, usually between 0.5% and 1%, that may apply to your available credit. Other possible fees include late fees, over-the-credit-limit fees and ATM withdrawal fees.

MoneyLion can help you find and compare financing offers, including lines of credit, from top lenders. Start your search today.

FAQ

Is a line of credit the same as a loan? 

A line of credit is a type of loan — namely, a revolving loan with a preset limit you can borrow against, repay and borrow against again. An installment loan, by comparison, provides a lump sum upfront that you repay through scheduled payments.

What credit score do you need for a line of credit? 

You generally need a credit score of at least 670 to qualify for a line of credit. You can still get approved with a low credit score, but you may see higher rates or less-than-ideal terms.

Can you pay off a line of credit early?

Yes, you can pay off a line of credit, and it's one way you can save on paying interest on the balance. If there are prepayment penalties, though, that will add to the total cost, so be sure to check that before you make the payment.

Does using a line of credit hurt your credit score?

Using a line of credit can hurt your credit if you don't make payments on time. It can also negatively impact your credit utilization rate if you're using too much — generally considered over 30% — of your credit limit at any given time.

How is interest calculated on a line of credit?

Lenders typically calculate interest on a line of credit daily by dividing your annual interest rate by 365, multiplying that daily rate by your outstanding balance, then applying it to the number of days in the billing cycle. Remember, interest starts accruing on a line of credit’s balance right away, and variable APRs can change over time.

Key Terms

• Line of credit: A revolving loan with a preset limit you can borrow against, repay and reuse during a set draw period, paying interest only on the amount you use.

• Draw period: The window, usually two to 10 years, when a line of credit is active and you can borrow against it.

• Revolving credit: Credit that replenishes as you repay, so your available balance goes back up. Non-revolving credit does not replenish.

• Variable APR: An annual percentage rate that can rise or fall over time alongside a benchmark index rate.

• Credit utilization rate: The share of your available credit you're using. Keeping it under 30% helps protect your credit score.

• HELOC (home equity line of credit): A line of credit secured by your home equity, meaning the house serves as collateral and could be lost if you default.

• Unused fee: A charge, often 0.5% to 1%, that some lenders apply to the portion of your line of credit you haven't borrowed.

• Hard inquiry: A credit check triggered by a formal application that can temporarily lower your credit score. Prequalifying usually avoids it.

Sources

• CFPB: Fixed vs. variable APR

• Federal Reserve (FRED): Personal loan interest rate, 24-month

• Federal Reserve (FRED): Credit card interest rate

• myFICO: What is a good credit score?

Summary generated by AI, verified by MoneyLion editors

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