A credit line is a financial agreement between a lender and borrower in which the lender extends a specified amount of revolving financing to the borrower over a specified period of time.
Unlike a standard loan, a credit line does not give the borrower a lump-sum check for the loan amount. Instead, the credit line provider provides the borrower with a checkbook, debit card or funded account that allows the borrower to draw against the credit line maximum amount.
There are various types of credit lines used in the financial world today. Some like credit cards have open-ended periods, while other credit lines have set terms and maturity dates.
When a line of credit has an established term or maturity date, the period in which the borrower is able to borrow the money is known as the drawing or draw period. The repayment period typically commences soon after the first draw is made against the account.
In order to qualify for a line of credit, the business or individual borrower must be deemed creditworthy by the creditor. So just like standard loans, the prospective borrower must satisfy the lender’s underwriting guidelines.
One of the best things about lines of credit is that interest is usually only applied if you actually use the amount of credit extended to you. For instance, if a $30,000 line of credit is extended to a business, that particular business will only incur interest expense if they decide to use any part of that credit line – and only against the actual amount borrowed against the credit line.
So if that business only used $4,500 of that credit line, then it would only pay interest on the $4,500 borrowed.
Credit lines are crucial tools for most companies. Because payments for their goods or services are often delayed by weeks or months, depending on the industry, businesses and corporations of all sizes use credit lines to purchase additional supplies, machinery, rent office space, make payroll, buy new equipment or improve the marketing strategies.
The most common type of credit lines already resides in most people’s wallets and purses: the credit card. Credit cards provide each user with a line of credit, which the borrower can use to make purchases – on credit. Although credit cards typically have expiration dates, most credit card accounts are actually open-ended. As long as borrowers maintain a good payment history and keep their credit eligibility, the credit account can be used indefinitely.
Another popular type of consumer credit line is the home equity line of credit, often called a HELOC. The HELOC is similar to a home equity loan, in that both are secured debts that are collateralized by the title to a home or other real property. Unlike a home equity loan, however, a home equity line of credit gives the borrower a revolving account, instead of one check for the entire loan amount.
In contrast to the HELOC, standard credit cards are often unsecured, which means that the debt or financing is not backed up by the borrower’s collateral. Some credit cards, especially for individuals with damaged credit, are secured credit cards. But standard credit cards are usually not.
Just like any loan or financing program, lines of credit require borrowers to meet their obligations. With most credit lines, the primary obligation is paying at least the minimum monthly payment required.
Whether the borrower is a business or individual consumer, failure to make required payments can result in default and termination of the credit line. If a credit line is terminated by the lender, the borrower is required to pay any remaining balance in full, right away.
Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.