Define Line of Credit

Individuals may borrow against a line of credit to make purchases. When the borrower makes payments on his line of credit, he frees up additional credit that he can again use to make purchases. Thus, lines of credit are categorized as "revolving" debt. Home equity loans and credit cards are two common types of credit lines.

Facts

Each line of credit carries a credit limit. The borrower may make purchases against the line of credit, but cannot surpass the limit. In some cases, his lender my allow him to surpass his credit limit up to a certain point, but charge him a penalty fee for doing so. Before extending a line of credit to a consumer, most lending institutions require him to meet certain credit criteria.

Features

Many banks expect borrowers to make payments on their credit lines monthly. Lines of credit carry a minimum payment. A borrower must pay at least the minimum payment, but can opt to pay more if she so chooses. Payments are based on the amount of the credit line the borrower uses, plus interest. Lenders only charge interest on the amount the borrower spends rather than the entire spending limit. In the event the individual surpasses her spending limit, however, the lender levies interest charges on the full spending limit plus the additional amount.

Types

Lines of credit may be secured or unsecured. According to the Federal Trade Commission, secured debts are connected to an asset, such as a borrower's home or vehicle. In the event the individual does not meet the minimum payments on his line of credit, the lender may recover the amount the borrower owes by seizing the secured item. Unsecured lines of credit are not tied to an asset and do not grant the lender the ability to claim any of the debtor's possessions as collateral should he default on the amount he owes.

Benefits

One of the benefits a line of credit offers is purchasing freedom. Because a line of credit allows the borrower to make purchases and pay for the items over an extended period rather than all at once, she can make large purchases that she may not possess the up-front cash to afford. In addition, a line of credit offers a consumer an alternative to short-term, high-interest loans, such as payday loans, when unexpected emergencies arise. In addition, should an individual opt for a home equity line of credit, she can write off the interest charges as a tax deduction.

Significance

A line of credit appears on the borrower's credit report. The amount he borrows and whether he makes timely payments directly affects his credit score and future buying power. The Fair Isaac Corp., the company that owns the FICO scoring formula, notes that each individual's payment history on his accounts makes up 35 percent of his credit score while the amount he owes his creditors makes up 30 percent of his credit score. Thus, the way a borrower manages his line of credit plays a role in determining his eligibility for additional credit and loans in the future.