A bank line of credit is money the bank agrees to lend you, up to a set limit, whenever you need it
A line of credit is not a loan. It is permission to borrow money on your own schedule, up to a maximum amount the bank decides. You do not receive the money all at once. Instead, you draw from it when you need cash — by writing a check, using a debit card, or transferring funds to your account — and you pay interest only on the amount you actually use, not the full limit.
The bank sets your credit limit based on your credit score, income, and payment history. If your limit is $10,000, you can borrow $2,000 one month and $8,000 the next. As you pay back what you borrowed, that money becomes available to borrow again. This is different from a term loan, where you get a fixed amount upfront and pay it back in set installments.
Lines of credit come in two main types: secured lines, which require collateral like a savings account or home equity, and unsecured lines, which do not. Unsecured lines typically have higher interest rates because the bank has no collateral to recover if you stop paying.
Key Takeaways
- You borrow only what you need from your credit limit and pay interest only on the amount you use, not the full limit.
- The bank sets your limit based on your credit score, income, and payment history, and the limit can change if your financial situation changes.
- Interest rates on unsecured lines of credit are usually higher than on secured lines because the bank has no collateral to recover.
- You must make at least a minimum payment each month, usually based on how much you have borrowed, and the bank can freeze or reduce your line if you miss payments or your credit score drops.
How the interest rate and fees work
Most bank lines of credit charge a variable interest rate, meaning the rate changes when the bank's prime rate changes. Your actual rate depends on the prime rate plus a margin the bank adds based on your creditworthiness. If you have a strong credit score, your margin might be 2 percent above prime; if your score is lower, it might be 5 or 6 percent above prime.
You pay interest only on the balance you carry. If your limit is $5,000 and you borrow $1,500, you pay interest on $1,500. Once you pay that $1,500 back, the interest stops accruing on that amount. Some lines of credit have a draw period — usually five to ten years — during which you can borrow and repay freely. After the draw period ends, you enter a repayment period during which you can no longer borrow and must pay off the remaining balance.
Banks often charge an annual fee, typically $25 to $100, just to keep the line open. Some waive the fee if you use the line regularly or maintain a minimum balance. A few lines also charge an inactivity fee if you do not use the credit for a set period. Read the disclosure document the bank provides before you open the line; it will list every fee.
What happens if you miss a payment or your credit score drops
If you miss a payment, the bank can freeze your line of credit, meaning you cannot borrow any more money, even though you still owe what you already borrowed. A single missed payment can also trigger a rate increase — some banks charge a penalty rate that is several percentage points higher than your regular rate.
The bank can also reduce or close your line of credit if your credit score drops significantly, your income declines, or you miss payments on other debts. This can happen even if you have never missed a payment on the line itself. Banks review accounts periodically and adjust limits based on current financial conditions. During economic downturns or recessions, many banks reduce lines across the board.
If your line is frozen or closed, you still owe any balance you have already borrowed, and you must pay it back according to the terms in your agreement. You cannot use the line to borrow more money, but the interest keeps accruing on what you owe.
The difference between a line of credit and a credit card
Both let you borrow up to a limit and pay interest only on what you use, but they work differently in practice. A credit card is designed for frequent small purchases and has a grace period — usually 21 to 25 days — during which you can pay the full balance with no interest. A line of credit has no grace period; interest starts accruing the moment you borrow.
Credit cards also have much higher interest rates, often 15 to 25 percent, while lines of credit typically range from 7 to 15 percent depending on the type and your credit score. Lines of credit are better for larger, less frequent borrowing — say, $3,000 to $10,000 — while credit cards work better for everyday spending you plan to pay off quickly.
Lines of credit also report to the credit bureaus differently. A credit card shows your credit utilization — how much of your limit you are using — which affects your credit score. A line of credit may not report utilization the same way, so using it may have less impact on your score, though missed payments will hurt you just as much.
When a line of credit makes sense and when it does not
A line of credit works well if you have irregular expenses you cannot predict — home repairs, medical bills, or business cash flow gaps — and you want to borrow only what you need when you need it. It is also useful if you want a lower interest rate than a credit card offers and you have good enough credit to get approved for an unsecured line.
A line of credit does not make sense if you are trying to avoid debt or if you struggle with impulse spending. Because the money is available whenever you want it, it is easy to borrow more than you intended. It also does not make sense if you need a fixed payment amount each month for budgeting purposes; lines of credit have variable rates and minimum payments that can change.
If you are considering a line of credit, compare offers from at least three banks. Ask about the starting rate, how the rate is calculated, what fees apply, and what happens to your rate and limit if your credit score drops. Some banks offer promotional rates for the first few months; make sure you understand what the rate will be after the promotion ends.
How to open a line of credit
Most banks require a credit score of at least 670 to 700 to open an unsecured line of credit, though some banks work with lower scores. You will need to provide proof of income, a government-issued ID, and permission for the bank to pull your credit report. The bank will also ask about your employment and existing debts.
The approval process usually takes three to five business days. Once approved, the bank will send you a disclosure document that explains the terms, rate, fees, and what happens if you miss a payment. Read this carefully before you sign. You can usually open the line online, by phone, or in person at a branch.
After the line is open, you can start borrowing immediately. The bank will provide you with a way to access the funds — a checkbook, a debit card, or online transfers. Keep track of how much you have borrowed and what your interest rate is. Set up automatic minimum payments so you do not miss a due date.
Frequently Asked Questions
Can the bank lower my credit limit without asking me?
Yes. Banks review accounts periodically and can reduce your limit if your credit score drops, you miss payments, or economic conditions change. You will usually receive a notice in the mail, but the bank does not need your permission to lower the limit.
What is the difference between a line of credit and a home equity line of credit?
A home equity line of credit (HELOC) is secured by your home, so the interest rate is lower and the limit is usually higher. A regular line of credit is unsecured and has a higher rate but does not put your home at risk if you default.
Do I have to use my line of credit once I open it?
No. You can open a line and never borrow from it. However, most banks charge an annual fee to keep the line open, even if you do not use it. Some banks waive the fee if you use the line at least once per year.
What happens to my line of credit if I declare bankruptcy?
The line will be closed and any balance you owe will be included in the bankruptcy. Depending on the type of bankruptcy you file, you may be required to repay part or all of the debt, or it may be discharged entirely. Speak with a bankruptcy attorney about how your specific situation will be handled.
Can I pay off my line of credit early without a penalty?
Most lines of credit have no prepayment penalty, so you can pay off the balance whenever you want. Check your disclosure document to confirm, as some older lines or lines from certain banks may have restrictions on early repayment.