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This guide will cover how lines of credit work and how you can apply for one. By the end, you'll know whether it's the right financing option for you.
A line of credit is a preset amount of money that you can borrow from as needed. The lender sets the credit limit, and you only pay interest on the amount that you borrow.
The difference between a loan and a line of credit is the greater flexibility a line of credit offers. When you get a loan, you'll receive the entire loan amount up front. The lender will start charging you interest on that amount right away, and you'll need to make fixed payments.
With a line of credit, you can borrow up to the credit limit at any time. As you pay down your balance on a line of credit, you'll also open up more available credit, and you can borrow from it again if you want.
There are two types of lines of credit:
With a line of credit, you're allowed to borrow as little or as much as you need -- up to the credit limit set by your lender. You only pay interest on the amount you borrow. As you repay your balance, more credit comes available.
Let's say a lender approves you for a $25,000 line of credit. You withdraw $5,000. The lender will start charging interest on just that $5,000. They'll also set a minimum amount you must repay every month. You'll still have $20,000 left in available credit.
Now, let's imagine that you've paid back $3,000. You could then borrow up to $23,000 from your line of credit because your available credit increases as you pay off your balance.
When a lender approves you for a line of credit, it will set all the terms, including:
As you may have noticed, a line of credit works in a very similar way to a credit card. A line of credit has three advantages:
If you only need a secure payment method that can help you build credit, then opening a credit card is the way to go. But if you need to borrow money, you're better off with a line of credit.
Here are the steps you can follow to get a line of credit:
The lender may make a decision on your application right away, or it may need time to review it.
Once you've been approved for a line of credit, you can make withdrawals. The way you do this depends on the lender. Many lenders transfer withdrawals directly to your bank account. There are also lenders that offer debit cards or checks you can use.
You'll receive your minimum payment amount and due date from the lender after you make a withdrawal. As you borrow more or repay your balance, your minimum payment amount will change.
Be careful about how much you withdraw from your line of credit. You'll be paying interest on each withdrawal, so it's not a good financial decision to use a line of credit -- or any form of credit -- for frivolous purchases. Whenever possible, you should also pay more than the minimum amount. You'll get your balance paid off more quickly and with less interest this way.
A line of credit can be a great choice if you need to finance large expenses or have an income that fluctuates from month to month.
If you have one or more big purchases coming up and you're not sure exactly how much they'll cost, a line of credit is ideal. You can withdraw as much as you need when you need it. A loan wouldn't work as well, because you could end up borrowing more or less than necessary. Here are a few examples of times when a line of credit is helpful:
You can also use a line of credit to help with cash flow if your income is different every month. Maybe you're a freelancer with clients who don't always pay as promptly as you like, or you're a business owner and sales vary quite a bit by season. In either case, a line of credit gives you a financial safety net when you need it.
Here are some other questions we've answered:
A line of credit is a financial product that allows you to borrow from a lender whenever you need money, up to a set credit limit. You're only charged interest on the amount you withdraw, and you can make multiple withdrawals as long as the line of credit is open and you haven't reached the credit limit.
As you repay the balance on your line of credit, you can reuse it. For example, you have a $10,000 line of credit, and you borrow the full $10,000. After you repay $5,000, you would be able to borrow up to $5,000 again.
After you've applied for a line of credit and been approved, you can borrow from it whenever you want. Lenders typically send these withdrawals through bank transfers.
The lender will set the credit limit (the maximum amount you can borrow) as well as the interest rate. You'll only pay interest on your withdrawals, rather than the whole balance. The lender will also determine the length of time that you can borrow from your line of credit. This is called the draw period.
When you make withdrawals, you'll receive a statement listing the current balance, the minimum payment amount, and the payment due date. You must pay the minimum amount on or before the due date. If you want, you can pay more than the minimum.
You can use a line of credit for anything you want -- there are no restrictions on how you use the money. Consumers often choose lines of credit for large expenses that don't have a fixed cost, such as home improvement projects. A line of credit is helpful when you don't know exactly how much money you'll need or when you'll need it. If approved, you'll have access to funds without committing to borrow any specific amount.
To get a line of credit, start by finding a lender that offers them. Many banks and credit unions do, and you may find that your current bank does as well. Check the lender's minimum and maximum line of credit amounts to decide how much you'll request. When you're ready, fill out an application either online or in person.
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