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

A line of credit is a revolving loan from a bank, credit union or online lender. It lets you borrow up to a set amount for a set draw period, with interest only accruing on the funds you use. Once you repay those funds, you can borrow against them again as needed. 

This guide will cover how lines of credit work, how they differ from other borrowing tools, like personal loans, and when to apply for one.

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What Is a Line of Credit and How Does It Work?

A line of credit is a type of revolving credit: You get approved for a preset limit that you can borrow against at any time. Once you do, you accrue fees and interest, usually as a variable annual percentage rate (APR), but only on the amount in use. 

As you repay those funds, they replenish — meaning you can access them again if and when a borrowing need arises. In the interim, you still have access to any unused funds within your credit limit, and you'll keep access to that credit limit for your full draw period, which usually lasts between two to 10 years. 

How a Line of Credit Works

Here's a quick, real-world example to illustrate how exactly a personal line of credit works:

• U.S. Bank approves you for a personal line of credit of up to $20,000 at a variable 21.9% APR.

• You borrow only what you need — say $10,000 for a home improvement project — by requesting a cash advance via direct deposit into your checking account.

• The bank advances the $10,000, and interest starts accruing immediately.

• You receive a monthly bill requiring at least a minimum payment of 1% of your outstanding $10,000 balance, plus accrued fees and interest. This bill is due 25 days after the close of each billing cycle. 

• You can pay more than the minimum, including the full outstanding balance, at any time. You opt to pay $2,000 back, plus all accrued fees and interest, within your first billing cycle.

• You now owe $8,000, still accruing fees and interest, but have access to the $12,000 of your credit limit that’s not in use.

Line of Credit vs. Personal Loan vs. Credit Card

Trying to decide between a line of credit, personal loan or credit card? Here's how each popular borrowing tool stacks up.

Line of Credit vs. Personal Loan

Lines of credit and personal loans differ most significantly in structure. Unlike a revolving line of credit, a personal loan is an installment loan. You receive full funding upfront, then make a fixed monthly payment over the loan's repayment term, usually two to five years.  

Personal loans generally carry fixed APRs. These APRs aren’t tied to an index, like the prime rate, so it’s highly unlikely they'll change over the life of your loan. Lines of credit, on the other hand, usually carry variable APRs tied to an index that can fluctuate. 

Given these key differences, personal loans are often better for funding large, one-time expenses, such as debt consolidation, a home improvement project or a medical expense. They’re a good fit for borrowers who want a predictable monthly payment and a fixed end date for their debt.

Lines of credit, conversely, are often better for funding expenses with unclear costs or long, spread-out stages, like a major home renovation. They're a good fit for borrowers who want flexibility or have recurring financial needs.  

Line of Credit vs. Credit Card

Lines of credit and credit cards are both revolving loans that let you access and reassess a pre-set borrowing limit as you repay. 

Credit cards let you do so with a credit card. Lines of credit typically require you to request cash, a check or an electronic funds transfer — though some may come with a specialized debit card for ATM withdrawals.  

Both typically charge variable APRs, though credit card rates tend to run a bit higher. Having said that, most credit cards come with a grace period that lets you avoid interest by paying off your balances in full by your monthly due date. Lines of credit typically don't come with grace periods. Instead, interest starts accruing right away. 

Given these key differences, credit cards are often better-suited to funding everyday purchases that you can pay off relatively quickly, while lines of credit may be better for large, irregular purchases, particularly if you'll need access to cash.

Comparing Lines of Credit vs. Personal Loans vs. Credit Cards 

When a Line of Credit Makes Sense — and When It Doesn't

While perhaps not as popular as personal loans or credit cards, a line of credit certainly has its use cases.  

When a Line of Credit May Make Sense

• You don't know how much money you actually need to borrow.

• You want to avoid paying interest on funds you might not use.  

• Your financial needs are spread over time or lack a clear start date.

• You're looking for a flexible, reusable borrowing tool.

• You have irregular income and frequently need to bridge large cash gaps. 

When Another Borrowing Option May Be Better

• You're funding a one-time large purchase with a clear cost.

• You need or want a structured, predictable repayment schedule.

• You want a fixed interest rate.

• You prefer simpler loan terms with fewer moving parts.

• You want a frictionless funding experience. 

Lines of Credit: A Red Flag and Green Flag Checklist

Still unsure if a line of credit is for you? Use this checklist to see whether it aligns with your borrower profile or current financial realities. 

Pros and Cons of a Line of Credit: What To Know Before Applying

Here's a handy guide to help you decide whether a line of credit is right for you.

Advantages of a Line of Credit

• Flexible borrowing amounts: You'll have access to a maximum credit limit, but you don’t have to borrow all — or any — of it. You can simply use funds as needed.

• Interest only accrues on what you use, unlike lump-sum personal loans, which require you to pay an APR of the full borrowed amount.    

• Funds “replenish” as you repay them: No need to reapply each time you request an advance during your draw period. 

• Potentially lower APRs than credit cards: Some lenders offer lines of credit with variable APRs that start as low as 11% or cap at 18%. Credit card rates currently average at around 21%.  

Are There Potential Risks to Using a Line of Credit?

• Variable APRs: Unlike personal loans, lines of credit typically carry variable APRs that may rise alongside benchmark index rates. 

• Draw fees and limits: Some lines of credit might charge a fee when you withddraw or there might be a cash advance fee each time you access your creditline. There might also be minimum or maximum withdrawal limits at ATMs.

• Eligibility requirements: While you can sometimes get a credit card or personal loan with bad credit, you'll generally need good credit to qualify for a line of credit.  

• Overspending risks: Because credit limits are flexible and "replenishible," you could wind up using more than you originally intended in the short and long term.

• Collateral: Secured lines of credit require collateral — and you might have to forfeit that collateral if you default.

What To Check Before Opening a Line of Credit

As you're comparing the different lines of credit, consider the following:

• APRs: Most lines of credit carry variable APRs. Competitive rates usually range between 11% and 21%, with lowest rates reserved for people with excellent credit scores. 

• Available credit limits: Lenders typically offer limits between $500 to $50,000, and a select few may even offer above that.  

• Fees: In addition to draw fees, a lender might charge an annual or maintenance fee, late fees, over-the-credit limit fees, ATM withdrawal fees and other ancillary charges. 

• Minimum payment requirements: The industry standard is typically between 1% to 3% of your outstanding principal, plus accrued fees or interest, or a flat fee, whichever is greater. 

• Draw limits and restrictions: In addition to imposing draw periods, some lenders require minimum or maximum draw amounts or set timeframes between advances. They might even prohibit some specific uses of the funds. For instance, you might not be able to use a personal line of credit for business-related expenses . 

• Access methods: Some lenders make it easier to access your credit line than others, allowing multiple disbursement methods, including direct deposit, ATM withdrawals, checks or more.

Considering this borrowing tool? You could start by comparing offers from these top personal lines of credit providers.

FAQs

Is a line of credit the same as a loan?

A line of credit is a revolving loan. Borrowers are approved for a preset limit that they can access as needed and re-access as they repay. Lines of credit differ from traditional personal installment loans, which are disbursed as a lump sum and repaid in fixed monthly payments over a set term.  

Do you pay interest on the full credit limit?

With a line of credit, you do not pay interest on your full credit limit; you only pay interest on the amount you've used. So if you have a $10,000 line of credit and borrow $5,000, only that $5,000 will accrue interest, albeit immediately. 

Does a line of credit affect your credit score?

A line of credit, like any other loan, can affect your credit score. When managed correctly, they can help you establish a strong payment history, diverse payment mix and otherwise boost your score. If you miss payments, get too close or go over your  limit and commit other credit faux pas, they could hurt your score. 

Is a line of credit better than a personal loan?

A line of credit isn't inherently better — or worse — than a personal loan. Ultimately, the “right” financing option comes down to your needs and borrower profile. A line of credit best serves people looking for long-term access and borrowing flexibility, for instance, while a personal line might best serve someone who wants a fixed APR, repayment term and monthly payment.

Sources:

• Consumer Financial Protection Bureau (CFPB). "What is a Personal Line of Credit?"

• CFPB. "What is the difference between a fixed APR and a variable APR?"

• Federal Reserve Bank of St. Louis. "Commercial Bank Interest Rate on Credit Card Plans, All Accounts."

• CFPB. "What is a credit card interest rate? What does APR mean?"