Lines of credit (LOCs) are preset borrowing limits that can be used whenever. The borrower can take money out as it is required until the limit is reached. As the money is repaid, in the case of an open line of credit it can be borrowed again.
LOCs are arrangements between a financial institution and a client that sets the maximum loan amount a customer can borrow. Borrowers can access funds from the line of credit at any time as long as they never go over the credit line’s maximum amount. Any other requirements like making timely payments of a certain minimum amount also have to be met.
How Lines of Credit Work?
The main advantage of a line of credit is its built-in flexibility. Lines of credit are open-end credit accounts that enable borrowers to spend money, then repay it, and then spend it all over again. The cycle never needs to end.
The lender sets how much interest is paid as well as the size of payments, and any other rules. There are lines of credit that allow the borrower to write cheques, while others offer credit or debit cards.
LOCs can be secured by collateral or unsecured. Unsecured LOCs usually have higher interest rates attached.
Unsecured vs. Secured LOCs
Most lines of credit are unsecured, which means borrowers don’t have to promise lenders any collateral. There is a notable exception: home equity lines of credit (HELOCs). These are secured with the equity in the home of the borrower.
Secured lines of credit are attractive for individuals and business owners because they normally are offered with higher maximum credit limits along with much lower interest rates than lines of credit that are unsecured. Unsecured lines of credit often require higher credit scores or credit ratings.