How a Line of Credit Works From Start to Finish

A line of credit offers a flexible financial tool that can provide access to funds for various needs. Unlike a traditional loan that disburses a lump sum, a line of credit establishes a maximum amount of money available for borrowing. This arrangement allows individuals and businesses to draw funds as needed, up to the approved limit, and repay them over time. This flexibility makes it a distinct option for managing cash flow or addressing unexpected expenses.

Core Concepts of a Line of Credit

A line of credit functions as a revolving credit facility, providing access to a set amount of funds that can be borrowed, repaid, and re-borrowed. This differs from an installment loan, where a fixed sum is received upfront and repaid in regular, scheduled payments over a defined period. With a line of credit, interest is typically charged only on the specific amount of money actually drawn, rather than on the entire approved credit limit. This means if you have a $10,000 line of credit but only use $2,000, interest accrues solely on that $2,000.

Key terms associated with a line of credit include the “credit limit,” which represents the maximum amount of money you are approved to borrow. “Available credit” refers to the portion of your credit limit that you have not yet used and is still accessible. For instance, if your credit limit is $15,000 and you have drawn $5,000, your available credit would be $10,000.

Common Types of Lines of Credit

Lines of credit come in various forms, each tailored to different financial needs and secured by different assets. An unsecured personal line of credit does not require collateral, meaning the lender relies primarily on the borrower’s creditworthiness and income for approval. These are often used for general expenses, consolidating debt, or covering unexpected costs, and typically have higher interest rates due to the increased risk for the lender.

Secured lines of credit, by contrast, require collateral, such as a savings account, certificate of deposit (CD), or other assets, to back the credit line. This collateral reduces the lender’s risk, often resulting in lower interest rates and potentially higher credit limits for the borrower. A common example of a secured line of credit is a home equity line of credit (HELOC), which uses the equity in a borrower’s home as collateral. HELOCs can offer substantial credit limits and favorable interest rates, making them suitable for major expenses like home renovations or educational costs.

Business lines of credit are also available, providing companies with flexible access to capital for operational expenses, inventory purchases, or managing cash flow fluctuations. Similar to personal lines, business lines can be secured by business assets or unsecured, depending on the borrower’s financial standing and the lender’s policies.

Applying for a Line of Credit

Before formally applying for a line of credit, individuals typically need to gather specific information and meet certain qualifications. Lenders assess an applicant’s creditworthiness through factors like credit score, income, and debt-to-income ratio. A strong credit history, characterized by consistent on-time payments and a low existing debt burden, generally improves the chances of approval and securing more favorable terms.

While minimum credit score requirements vary by lender, a FICO score of 660 or higher is often considered good for personal lines of credit, with scores of 713 and above offering the best approval odds. The average FICO score in the U.S. was 715 in early 2025.

Applicants will commonly need to provide documentation to verify their identity and financial standing. This typically includes government-issued identification, such as a driver’s license or passport, to confirm identity. Proof of income is also essential, often satisfied by recent pay stubs, tax returns, or bank statements, allowing the lender to assess repayment ability.

For secured lines of credit, documentation related to the collateral, such as property deeds for a HELOC, will be required. Lenders may also request expense statements, existing credit statements, or bank account details.

The application process can often be initiated online, in person at a financial institution, or over the phone. Lenders will conduct a credit check to review the applicant’s borrowing behavior and credit score.

Using and Repaying a Line of Credit

Once a line of credit is approved and established, accessing funds is typically straightforward. Borrowers can draw money up to their available credit limit through various methods, which may include writing checks linked to the line of credit, initiating online transfers to a checking account, or using a linked debit card. Funds can be accessed as needed, rather than receiving a single lump sum.

This interest is typically variable, meaning it can fluctuate with market rates, though some lenders might offer fixed-rate options. Minimum monthly payments are required and are usually determined by the outstanding drawn balance, often including accrued interest and a portion of the principal. These payments ensure that the account remains in good standing.

This allows for repeated use of the funds without needing to reapply for new credit, as long as the account is managed responsibly and within the terms of the agreement. Some lines of credit may have a “draw period” during which funds can be accessed, followed by a “repayment period” where no new funds can be drawn, and the outstanding balance must be paid off.