How Are Lines of Credit Determined?

A line of credit is an amount of money that a financial institution is willing to extend to an individual or business. Unlike a loan, with a line of credit, an individual can only borrow as much money against the credit line as he wishes. When an individual draws money against the line, he is required to pay back the money he borrowed within a set period of time at a set rate of interest.

Lines of Credit

The most popular form of credit line is a credit card. When a person uses a credit card, he is merely drawing money against a line of credit set up with institution that issued the credit card. Other kinds of credit lines include home equity credit lines--a credit line secured by the equity of a property--or a business lines of credit, secured by a business's assets. Each line has its own terms.

Amount of Line

The chief difference between lines is the size of the line of credit, which a financial institution determines through several different methods. For a secured line of credit, such as a line secured by a home's equity, the amount of the line usually matches the value of the asset securing it. The size of an unsecured line of credit, such as a credit card, will be determined based on the individual's income and credit history.

Interest Rates

The interest rate that an individual receives on his credit line is generally determined by his credit rating. Individuals with superior credit ratings receive lower rates on interest on their credit lines, while individuals with lower credit ratings get steeper rates. Generally, the interest rates on secured lines of credit are lower than on unsecured lines of credit because the financial institution runs less of a risk; it has collateral it can seize in the event of a default.

Considerations

Every finance company has its own methods for determining how large a line of credit to extend to customers and what interest rate to charge. While some companies may put more value on the collateral, others may focus more on the customer's income and credit rating. This is the reason that many individuals seeking lines of credit go to several lenders and compare terms.