Line of Credit (LOC)

Posted on by user

Line of Credit (LOC): Definition, Types, and How It Works

A line of credit (LOC) is a flexible loan that lets a borrower access funds up to a lender-set limit, repay what’s borrowed, and borrow again as needed. Interest is charged only on the outstanding balance, not on the full credit limit. LOCs are offered to individuals and businesses and can be secured (backed by collateral) or unsecured.

Key takeaways

  • LOCs provide on-demand access to funds up to a preset limit; interest accrues only on amounts borrowed.
  • Common types: personal LOCs, business LOCs, home equity lines of credit (HELOCs), demand lines, and securities-backed LOCs.
  • Secured LOCs (e.g., HELOCs, SBLOCs) usually have lower rates and higher limits; unsecured LOCs require stronger credit and carry higher rates.
  • Many LOCs are revolving (replenish as you repay); non-revolving LOCs do not replenish after full repayment.
  • High utilization (commonly cited threshold: >30%) and missed payments can harm your credit score; applying triggers a hard credit inquiry.

How lines of credit work

  • Approval and limit: Lenders evaluate creditworthiness, income, and collateral (if any) to set a borrowing limit.
  • Access and repayment: Borrowers draw funds as needed (checks, debit cards, transfers), repay principal and interest, and can re-borrow up to the limit if the LOC is revolving.
  • Interest and payments: Interest is typically variable and charged only on the outstanding balance. Some LOCs require interest-only payments for a set period, then principal amortization.
  • Secured vs unsecured: Secured LOCs use collateral (home equity, securities) which reduces lender risk and often lowers the rate; unsecured LOCs rely on credit history and typically cost more.

Secured vs. unsecured LOCs

  • Secured LOCs
  • Backed by an asset (home or investment portfolio).
  • Higher borrowing limits and lower interest rates.
  • Lender can seize collateral if you default.
  • Unsecured LOCs
  • No collateral required.
  • Higher interest rates and stricter credit requirements.
  • Credit cards are a common form of unsecured revolving LOC.

Revolving vs. non-revolving LOCs

  • Revolving LOC: Funds become available again as you repay. Examples: most personal lines and credit cards, HELOCs during their draw period.
  • Non-revolving LOC: Once repaid in full, the account is closed and cannot be reused without reapplying. Terms vary by lender.

Common types of lines of credit

  • Personal line of credit
  • Typically unsecured; used for emergencies, irregular income smoothing, projects, or large purchases.
  • Qualification often requires a solid credit history and steady income.
  • Home equity line of credit (HELOC)
  • Secured by home equity (usually a percentage of market value minus mortgage balance).
  • Often has a draw period (e.g., 10 years) followed by a repayment period.
  • May involve closing costs and an appraisal.
  • Interest may be tax-deductible only when used to buy, build, or substantially improve the secured property (tax rules vary).
  • Business line of credit
  • Provides working capital and short-term liquidity; can be secured or unsecured based on size and business creditworthiness.
  • Interest rates are usually variable.
  • Demand line of credit
  • Lender may call the loan due at any time; repayment terms depend on agreement.
  • Securities-backed line of credit (SBLOC)
  • Secured by brokerage account holdings; loan-to-value ratios typically range widely (e.g., 50–95% depending on assets).
  • Usually interest-only payments until repayment or until the lender demands repayment if portfolio value falls below required levels.
  • Often restricted from using proceeds to buy more securities.

Limitations and risks

  • Variable rates: Most LOCs have variable interest, which can increase borrowing costs.
  • Higher costs for unsecured credit: Unsecured LOCs and credit cards often carry higher APRs.
  • Less consumer protection: Some LOC types don’t have the same protections as credit cards; penalties for late payments or exceeding limits can be severe.
  • Overspending risk: Ready access to credit can encourage excessive borrowing and financial strain.
  • Credit impact: A hard inquiry when you apply can temporarily lower your score; high utilization and missed payments hurt creditworthiness.

How an LOC affects your credit

  • Application triggers a hard credit inquiry.
  • Ongoing impacts include utilization (high balances relative to limits lower your score) and payment history (late payments damage your score).
  • Keeping utilization below roughly 30% and making on-time payments helps preserve credit health.

Typical uses

  • Emergency expenses
  • Home improvements or large projects
  • Working capital for businesses
  • Cash flow smoothing for irregular income
  • Short-term financing needs where flexibility is important

Bottom line

A line of credit is a versatile borrowing tool that offers flexible access to funds and interest charged only on what you borrow. Choose between secured and unsecured options based on your needs, risk tolerance, and credit standing. Be mindful of variable rates, credit impacts, and the temptation to overspend—use LOCs as a planned liquidity strategy rather than a long-term spending crutch.