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

A line of credit and a credit card both offer flexible ways to access funds, serving as common financial tools for individuals. While they possess distinct characteristics, a fundamental understanding reveals significant operational similarities. This article explores the shared attributes of these two credit products, focusing on how they function and impact a user’s financial standing.

Understanding Revolving Credit

Both a line of credit and a credit card operate under the principle of revolving credit. This financial arrangement allows a borrower to repeatedly access, repay, and then re-access funds up to a predetermined maximum amount. Unlike installment loans, such as a car loan or mortgage, where a fixed sum is borrowed and repaid over a set period, revolving credit offers ongoing access to funds.

The core mechanism involves a credit limit, which is the maximum amount of money available for borrowing. As funds are repaid, the available credit replenishes, enabling the borrower to draw from it again without needing to reapply. This continuous access to credit differentiates revolving products from term loans.

Accessing Your Credit Limit

Credit cards and lines of credit provide similar mechanisms for accessing approved funds. With a credit card, users typically make purchases directly at points of sale or online, drawing against their available credit limit. Additionally, cash advances can be obtained from an ATM or financial institution, and balance transfers allow the movement of debt from one card to another.

Similarly, a line of credit offers various methods for fund withdrawal. Borrowers often access funds by writing checks against their available credit, initiating direct transfers to a linked checking account, or in some cases, using a dedicated debit card.

Repaying Borrowed Funds

The repayment structures for credit cards and lines of credit share many commonalities. Both products typically require borrowers to make regular minimum payments. These minimum payments are calculated based on the outstanding balance, interest accrued, and sometimes a small portion of the principal.

Interest begins to accrue on the borrowed balance, usually at a variable annual percentage rate (APR), from the date of the transaction or the end of a grace period. Each payment made is first applied to any accumulated interest, with the remainder reducing the principal balance. Borrowers have the flexibility to pay more than the minimum amount due, which can significantly reduce the total interest paid over time and free up available credit more quickly.

Common Associated Costs

Several types of fees and charges are commonly associated with both lines of credit and credit cards. The Annual Percentage Rate (APR) represents the yearly cost of borrowing and is a primary expense for both products, varying based on creditworthiness and market conditions. Many credit cards and some lines of credit may also charge an annual fee.

Late payment fees are a standard penalty imposed when a payment is not received by the due date, typically ranging from $30 to $41, depending on the card issuer or lender. Drawing cash from either a credit card or a line of credit often incurs a cash advance fee, which can be a flat amount or a percentage of the transaction, commonly 3% to 5%. Other charges might include over-limit fees or foreign transaction fees, though the latter is more prevalent with credit cards used internationally.

Influence on Your Credit Profile

The management of both a line of credit and a credit card significantly impacts an individual’s credit profile. A consistent history of timely payments on either account demonstrates financial responsibility and positively contributes to a credit score. Payment history is a primary factor credit scoring models consider.

The credit utilization ratio, which is the amount of credit used compared to the total available credit, also plays a substantial role. Maintaining a low utilization rate on both types of accounts can benefit credit scores, while high utilization may indicate increased risk. The length of time accounts have been open and in good standing also contributes to a stronger credit history. Conversely, late payments, defaults, or high credit utilization on either a credit card or a line of credit can negatively affect a credit score.