A line of credit is money a bank agrees to lend you, up to a set limit, that you can borrow from whenever you need it

Unlike a loan where you receive a lump sum all at once, a line of credit works like a flexible account. The bank sets a maximum amount—say $10,000—and you can draw from it in whole or in part, repay what you borrowed, and borrow again. You only pay interest on the money you actually use, not on the full limit. It sits between a credit card and a traditional loan in how it works.

Most bank lines of credit are unsecured, meaning you do not pledge collateral like a house or car. The bank's decision to offer you one depends on your credit score, income, and payment history. The interest rate is usually lower than a credit card but higher than a mortgage, and it can be fixed or variable—meaning it may change if the bank's prime rate changes.

You access the money by writing a check, using a debit card tied to the account, or requesting a transfer to your checking account. Some lines of credit have a draw period—typically five to ten years—during which you can borrow. After that, you enter a repayment period where you can no longer draw new money and must pay back what you owe.

Key Takeaways

  • You pay interest only on the money you actually borrow, not on the full credit limit the bank offers you.
  • A line of credit is unsecured, so approval depends on your credit score and income, not on collateral.
  • Interest rates vary by bank and your creditworthiness, but are typically lower than credit cards and higher than mortgages.
  • Most lines of credit have a draw period (when you can borrow) followed by a repayment period (when you pay back what you owe).
  • You can access the money by check, debit card, or bank transfer, making it faster than waiting for a loan to close.

How the interest and fees work

Interest on a line of credit accrues only on the balance you carry. If your limit is $10,000 but you borrow $3,000, you pay interest on $3,000. The rate itself depends on the bank, your credit score, and current market conditions. A person with a credit score above 750 might receive a rate of 7% to 9%, while someone with a score below 650 might see 12% to 18% or higher.

Beyond interest, watch for annual fees (some banks charge $25 to $100 per year just to maintain the account), inactivity fees (charged if you do not use the line for a set period), and transaction fees (if you exceed a certain number of withdrawals). Some banks waive the annual fee if you maintain a minimum balance or use the line regularly. Read the disclosure document the bank provides before you accept the line—it will list every fee.

If you miss a payment or go over your limit, expect late fees and possible rate increases. A single missed payment can trigger a penalty rate that applies to your entire balance, sometimes jumping from 8% to 18% or more. This is why a line of credit, despite its flexibility, still requires disciplined repayment.

When a line of credit makes sense versus other borrowing options

A line of credit works well if you have irregular expenses you cannot predict in advance—home repairs, medical bills, or business cash flow gaps. You borrow only what you need and only when you need it, avoiding the cost of a large loan you might not fully use. It is also faster to access than a traditional loan; once approved, you can draw money within days rather than waiting weeks for closing.

A credit card is more convenient for small, frequent purchases and offers fraud protection, but carries a much higher interest rate—often 18% to 25%. A personal loan gives you a fixed payment and a set end date, which some people prefer for budgeting, but you pay interest on the full amount even if you do not need all of it when ready. A home equity line of credit (HELOC) uses your house as collateral and typically offers a lower rate, but puts your home at risk if you cannot repay.

A line of credit is less suitable if you need a large, one-time sum of money—a car purchase or home down payment—because a traditional loan with a fixed term is simpler and often cheaper. It is also not ideal if you struggle with impulse spending, because the ease of access can lead to borrowing more than you can comfortably repay.

The draw period and repayment period explained

Most lines of credit operate in two phases. During the draw period, usually five to ten years, you can borrow and repay as often as you want. You make minimum payments (often interest-only) on whatever balance you carry. This flexibility is the main appeal—you can pay down the balance to zero, then borrow again if needed.

When the draw period ends, the line enters the repayment period, typically ten to twenty years. You can no longer borrow new money. Instead, you must repay the full outstanding balance on a fixed schedule, usually with equal monthly payments. If you owe $5,000 at the start of the repayment period and the term is ten years, you will pay that $5,000 plus interest in equal installments over 120 months.

This transition can catch people off guard. If you have been making interest-only payments during the draw period, your payment will jump significantly once repayment begins. Plan ahead: if your draw period ends in three years and you still carry a balance, calculate what your repayment payment will be and make sure your budget can handle it.

How to get approved for a line of credit

Banks evaluate your creditworthiness using several factors. Your credit score is the first filter—most banks require a score of at least 650 to 700, though better rates go to scores above 750. Your income must be stable and documented; the bank will ask for recent pay stubs or tax returns. Your debt-to-income ratio—how much you already owe compared to what you earn—matters too. If you already carry high credit card balances or other loans, the bank may offer a smaller limit or deny you altogether.

The bank will also check your payment history. A single late payment from years ago is less damaging than recent missed payments. If you have filed for bankruptcy, most banks will wait at least two to three years before considering you, though some require five to seven years.

To strengthen your case, bring documentation: recent pay stubs, tax returns for the past two years, a list of your current debts and monthly payments, and your credit report (you can get a free copy at annualcreditreport.com). If your credit score is below 700, ask whether the bank offers a secured line of credit, where you deposit money as collateral—this is easier to obtain and can help you build credit for a future unsecured line.

What happens if you cannot repay

If you fall behind on payments, the bank will contact you to collect. Late fees and penalty interest rates kick in when ready. After 30 days of missed payments, the bank may freeze your line, preventing further borrowing. After 60 to 90 days, the bank may charge off the account and sell the debt to a collection agency.

A charged-off line of credit damages your credit score significantly and stays on your credit report for seven years. Collection agencies can sue you for the balance, and if they win, they can garnish your wages or place a lien on your property (depending on your state's laws). Some states allow wage garnishment; others do not. If you are struggling to repay, contact the bank before you miss a payment—many offer hardship programs that lower your payment temporarily or reduce your interest rate.

Bankruptcy is a last resort, but it is an option if your debt is overwhelming. Chapter 7 bankruptcy can discharge unsecured debts like a line of credit, though it damages your credit for ten years. Chapter 13 allows you to reorganize your debts and repay over three to five years. Consult a bankruptcy attorney in your state to understand your options; many offer free initial consultations.

Frequently Asked Questions

Does opening a line of credit hurt my credit score?

Yes, initially. The bank performs a hard inquiry, which lowers your score by a few points. Opening a new account also lowers your average account age. However, once the account is open and you use it responsibly, it can help your score by lowering your credit utilization ratio—the percentage of available credit you are using. Over time, the positive impact usually outweighs the initial dip.

Can I use a line of credit to pay off credit card debt?

Yes, and it often makes financial sense. If your line of credit carries a 9% interest rate and your credit cards charge 20%, transferring the balance saves you money. However, make sure you do not run up the credit cards again while paying off the line of credit—that doubles your debt. Some people find it helpful to close the credit card accounts after paying them off, though this can slightly lower your credit score.

What is the difference between a line of credit and a HELOC?

A HELOC (home equity line of credit) uses your house as collateral, so the bank can foreclose if you do not repay. In exchange, HELOCs offer lower interest rates, usually 6% to 9%. A standard line of credit is unsecured, so the bank cannot take your home, but the interest rate is higher. Choose a HELOC only if you are confident you can repay and comfortable risking your house.

What happens to my line of credit if I do not use it?

Some banks charge inactivity fees if you do not borrow or make a payment within a set period, typically 12 months. Others may close the account without warning. Check your disclosure document for the bank's inactivity policy. If you want to keep the line open but do not need to borrow, make a small purchase and pay it off each month to show activity.

Can I increase my line of credit limit?

Yes. After six months to a year of on-time payments, you can request a higher limit. The bank will review your credit score and income again. Some banks offer automatic increases if your creditworthiness improves. Requesting an increase triggers a hard inquiry, which lowers your score slightly, so do not request increases too frequently.