How a Line of Credit Works

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Image shows four icons: a home sitting on top of money, a hand signing an application, a credit card bill, and an ATM in overdraft. Text reads: "4 types of lines of credit: Home equity lines of credit (HELOC): Borrow as much money as you need with your home's equity as collateral. Personal lines of credit: Draw money when keededvia an access card of ATM, or written checks. Credit card lines of credit: Borrow money within your credit card limit. Overdraft lines of credit: Borrow small amounts of money when you overdraft your checking account."

The Balance / Maddy Price

Key Takeaways

  • A line of credit works like a loan, but instead of a lump sum of money, you have an available balance from which you can spend when needed.
  • Like a loan, you're still borrowing this money and you'll need to pay it back and you may have to pay interest on it.
  • Examples of lines of credit include a credit card and a home equity line of credit (HELOC).
  • Know exactly what you're getting into. Not all lines of credit are created equally, and not all assert the same terms. Shop for the best deal with your personal situation in mind. Compare your options.

A line of credit is a pool of money that you can borrow from as you need. A credit card is a common example of a line of credit, where you have an available balance up to which you can spend. Of course, you need to pay it back and you may be charged interest. A line of credit works differently from a loan because a loan is a lump sum and you may have different terms and interest rates. There are a few types of lines of credit, and you may not have to borrow money from the line of credit (or pay interest on it) until you decide you need the funds.

How Do Lines of Credit Work?

A line of credit is an available balance from which you can borrow money and use before paying it back, sometimes with interest. Different lines of credit work differently.

A credit card allows you to borrow money from your credit line and then pay it back by a certain due date. If you do not pay it back in full by that date, you'll be charged interest. You can have a credit card for years with a revolving line of credit that may go up as your credit score and experience improve.

A home equity line of credit (HELOC) is another type of line of credit. It comes with a draw period and a repayment period.

The draw period is the time that you have access to the credit—that's when you can borrow the money. This stage might last for 10 years or so, depending on the details of your agreement with the lender. The repayment period is when you will repay the principal and interest on the line of credit. However, you will also be expected to make minimum payments during the draw period. A portion of those payments will go toward reducing your interest costs. The portion of your payments that go toward the principal can be added back to your credit line for future borrowing, but this replenishing effect isn't the case with all lines of credit.


With some lenders, your payments during the draw period will represent only interest. This is another factor that will depend on the specifics of your credit line agreement.

The major difference between the draw period and your repayment period is that, when you enter the repayment period, you'll be given a set period within which you're expected to pay off your entire debt.

As you look toward your repayment period, use our loan calculator to understand the long-term cost of your line of credit:

When Should You Open and Use a Line of Credit?

Before you open a new line of credit, it's important to be sure that you can pay it off every month. For example, if you're unsure where your next paycheck will come from, a line of credit may not be wise since you won't be able to pay it off. Of course, you have to do what is best for your financial situation and a line of credit could help you in a time of financial need.


As with most types of lending, your credit score is critical. If your score isn't great now, you might want to delay taking out a line of credit, if possible, so that you can get the lowest interest rate possible. This will help you rack up less debt. Some lenders also require a certain credit score, so know yours before applying.

Like any loan, it's rarely advisable to take out a line of credit for "wants" rather than "needs." That means it probably isn't a good idea to use a line of credit to fund a dream vacation or major shopping spree.

A line of credit may be best used for:

  • Major purchases
  • Financial emergencies
  • Home repairs or renovations
  • Higher education
  • Debt consolidation

If you're taking out the line of credit to help meet monthly expenses, your finances could quickly spiral into debt. Paying for this month's expenses with debt is just going to increase next month's expenses.

Secured and Unsecured Lines of Credits

Lines of credit are typically "unsecured," but some are "secured," which means that the borrower is required to put up collateral. The lender will place a lien against some item of your property, typically your home or your vehicle, but you might also be able to pledge a bank account or a certificate of deposit (CD).


A lien acts as security if you default on a loan or line of credit. The lender can foreclose or repossess your collateral if you fail to meet the terms of the loan.

Lines of Credit vs. Personal Loans

Lines of Credit vs. Personal Loans
Lines of Credit Personal Loans
Term may be longer Term may be shorter
Borrowed amount is flexible Borrowed amount is set
Borrowed amount is disbursed when needed Borrowed amount is disbursed in a single lump-sum

A line of credit will typically cost you a bit more in the way of interest than a personal loan would, at least if it's unsecured, but that's not always true. Interest rates may be different from different banks and your personal interest rate will depend on your credit score and report.

Taking out a personal loan involves borrowing a set amount of money in one lump sum. You can't go on paying the principal back and then reusing it as you can with a line of credit. It may also only be something you can use for a set amount of time, with a shorter repayment term than a line of credit.

For example, let's say you take out a line of credit worth up to $10,000. You do not get $10,000 sent to your checking account. You would have a separate way of managing the line of credit and could use the money when needed. You may have a draw period when you can access the money and pay monthly minimum payments. Then you may have a repayment period when you have to pay interest and the remaining principal balance back by a certain date years and years in the future.

On the other hand, let's say you take out a personal loan worth $10,000. You would get the money sent to your account within a few days. You could start using it immediately. You would also need to start repaying it immediately, with a monthly payment made up of a principal amount and an interest charge. The term of the loan may be just a few years long.

Types of Lines of Credit

There are a few main types of lines of credit: home equity lines of credit (HELOCs), personal lines of credit, credit cards, and overdraft lines of credit. Learn more about each below so you can decide which is right for you.

Home Equity Lines of Credit (HELOC)

One of the most common lines of credit for consumers is a home equity line of credit (HELOC). This is a secured loan. Your home's equity—the difference between its fair market value and your mortgage balance—serves as the collateral. Your HELOC forms a lien against your property, just like your first mortgage. Your credit limit is determined by your loan-to-value ratio, your credit scores, and your income.

These lines of credit are popular because they allow you to borrow relatively large amounts at relatively low interest rates compared to credit cards or unsecured loans. Banks consider these loans to be quite safe because they assume you'll repay the line of credit to avoid losing your home in foreclosure. Many homeowners use HELOCs for home renovation, emergency expenses, or other large purchases.

Personal Lines of Credit

A bank may offer a personal line of credit from which you can draw money when needed via an access card or ATM, or written checks. There may be a credit score requirement, a limit on how much you can borrow, and a variable interest rate. Personal lines of credit may be secured or unsecured.

Credit Cards

Your credit card is effectively a line of credit. You get to borrow up to a maximum limit. As you repay what you borrowed, that maximum limit is replenished. You can repeat this cycle of borrowing and repaying numerous times.

One major difference with credit cards compared to other lines of credit is that you'll most likely pay an increased interest rate if you try to take cash. This is known as a cash advance, and it typically comes with different rates than when someone directly charges a purchase at the point of sale.

Another major difference is that you may not have a defined term for your credit card. While a HELOC may have a term of up to 10 years for a draw period, a credit card may be available to you for an indefinite period of time—until you or the credit card provider close the account.


Credit cards can be secured or unsecured.

Overdraft Lines of Credit

Another line of credit is the overdraft line of credit. These lines of credit are typically available for your checking account. It's essentially a small loan that is only triggered if you spend more than you have available in your account. The amount of the loan is just enough to bring your account back in the black again. It's usually less expensive than an overdraft fee, assuming you only overdraw by a few bucks. For example, U.S. Bank offers a reserve line of credit for those who may need more money but do not have it in their checking account. Fulton Bank also offers an overdraft line of credit.

Frequently Asked Questions (FAQs)

How do you get a line of credit?

To get a line of credit, you need to apply for one with a lender like a bank or credit union. You'll provide personal information such as your annual income, employer, and home address. The lender will perform a credit check to verify your information and assess your riskiness as a borrower. The application process may be quick and you could get approval within minutes, but lenders may take a few business days to send you everything you need to start using the line of credit.

How many lines of credit should you have?

There isn't a specific number of credit lines that's best for everyone, because it'll depend on other aspects of your credit report. In general, it's a good idea to simply utilize a small percentage of your total credit amount. Using just 10% of each credit line can help you maintain a good credit score. So you can have one or five lines of credit, just make sure you can pay them off so you don't end up with debt that is difficult to repay.

How do you increase your line of credit?

Increasing your line of credit starts with increasing your credit limit and that can be as easy as simply calling up customer service and asking. Lenders can increase or decrease your line of credit at their discretion. If you have a history of paying on time and in full, your lender is more likely to increase your credit limit, and it may even do so automatically.

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The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Consumer Financial Protection Bureau. "My Lender Offered Me a Home Equity Line of Credit (HELOC). What Is a HELOC?"

  2. U.S. Bank. "Personal Line of Credit."

  3. Consumer Financial Protection Bureau. "What Is a Personal Line of Credit?"

  4. Federal Trade Commission Consumer Advice. "Credit, Debit, and Charge Cards."

  5. U.S. Bank. "Reserve Line of Credit."

  6. Fulton Bank. "Overdraft Line of Credit."

  7. "Credit Reports and Credit Scores."

  8. Wells Fargo. "Credit Card FAQs: How Do I Increase My Credit Line?"

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