How Is a Line of Credit Similar to a Credit Card?

A line of credit represents a flexible loan arrangement, allowing individuals to borrow funds up to a predetermined maximum amount. Similarly, a credit card provides a means to make purchases or obtain cash advances on credit, also up to an established limit. Both financial products function as forms of revolving credit, enabling users to access funds repeatedly as borrowed amounts are repaid.

Core Principles of Accessing Funds

Both a line of credit and a credit card operate under the principle of revolving credit, which means that funds become available again as the borrowed amount is repaid. This characteristic distinguishes them from installment loans, where a lump sum is disbursed and repaid over a fixed period, after which the account closes. With revolving credit, the account remains open, allowing for continuous borrowing and repayment cycles.

A central feature common to both products is the “credit limit,” representing the maximum amount of money that can be borrowed or spent at any given time. This limit is set by the financial institution based on the borrower’s creditworthiness, income, and employment status. As funds are used, the available credit decreases, and as payments are made, the available credit replenishes, allowing for re-use of the funds up to the established limit.

Accessing funds from a line of credit often involves transferring money to a checking account, writing special checks, or sometimes using a dedicated debit card. For credit cards, funds are typically accessed through direct purchases at merchants or by obtaining cash advances. In either scenario, the user draws directly against their established credit limit, benefiting from the flexibility to use funds as needed without requiring a new application for each draw.

Repayment and Cost Structures

Both lines of credit and credit cards typically charge interest on outstanding balances. Interest generally begins to accrue on the borrowed amount from the transaction date if the balance is not paid in full by the due date. Interest is commonly calculated using the average daily balance method, where a daily interest rate is applied to the balance each day, and these daily charges are summed for the billing period.

Users of both products are subject to minimum payment requirements, meaning they must pay at least a small portion of the outstanding balance, including accrued interest and any fees, by a specific due date each billing cycle. Making only the minimum payment extends the repayment period significantly and increases the total amount of interest paid over the life of the debt. Financial institutions commonly outline these minimum payment calculations, which might be a fixed amount or a percentage of the outstanding balance.

Common fees can also apply to both credit products when terms are violated or specific services are utilized. These may include late fees for missed payments or over-limit fees if the outstanding balance exceeds the credit limit, though some issuers do not charge over-limit fees.

Influence on Credit Standing

Both lines of credit and credit cards are reported to major credit bureaus, making them significant components of an individual’s credit report. The way these accounts are managed directly impacts a person’s credit standing. Responsible use, such as consistently making on-time payments, can positively influence credit scores. Payment history is a major factor in credit scoring models.

Conversely, irresponsible use, including missed payments, late payments, or defaulting on the account, can severely damage credit scores. Even a single payment that is 30 days or more past due can negatively affect scores. Both products also contribute to an individual’s credit utilization ratio, which is the percentage of available credit being used. Keeping this ratio low, generally below 30%, is considered beneficial for credit scores.