What Does a Line of Credit Mean?

When a person borrows money from another party, the money that is borrowed is considered a loan. Generally, loans are issued at a particular rate of interest that the borrower must pay back with the principal. However, when a lender extends a borrower the option, but not the obligation, to borrow a certain amount of money at a set rate of interest, this is known as a line of credit.

Features

Lines of credit are generally offered by financial institutions, such as credit card companies and banks. In some cases, the line of credit will be offered at a fixed rate of interest, meaning that the amount of interest the person pays on the loan will stay consistent with time. Other lines of credit are offered at floating rates of interest, meaning the amount of interest the borrower pays will vary with the prevailing rate of interest.

Types

Some lines of credit are backed with a form of collateral. For example, many homeowners will take out lines of credit using a portion of the house as collateral: these are known as home equity credit lines. However, some lines of credit are unsecured. For example, the amount that a person is allowed to charge on their credit card is considered a line of credit.

Loans Versus Lines of Credit

Lines of credit differ from loans in several ways. First, while loans are issued to a borrower in the form of a single lump sum, withdrawals taken from a line of credit may be taken in a number of installments, such as through charges on a credit card. Also, according to Creditor Web, a line of credit application is generally simpler, taking only a few days, as opposed to a few weeks with a loan.

Advantages

The chief advantage of a line of credit over a loan is that it allows the person to take out only what he needs to borrow, when he needs to borrow it. With loan, a borrower may often be obligated to take out a larger amount than he actually needs, such as on certain mortgages. Also, lines of credit backed with collateral can help borrowers keep their debt manageable by placing limits on the loan they take out.

Requirements

The requirements for receiving a line of credit are also identical to those needed to receive a loan. In both cases, a person's credit history is considered, as is their current ability to pay back the money being offered. In both cases, the lender may consider the person's credit report, as well as documents indicating their current financial position.