Oftentimes when people need money, the last thing they consider is seeking a line of credit. However, it is a critical component when applying for a loan.
What is it?
A line of credit (LOC) is a flexible loan issued by a bank or other financial institution. Much like credit cards that offer a limited amount of funds – ones that you can use however and whenever you like – a LOC is a specific amount of money that one can access as needed. They can be repaid either immediately or over a pre-established period of time.
With loans, a line of credit typically charges interest as soon as money is borrowed. Borrowers must receive approval from the bank, with this consent being a byproduct of the borrower’s credit rating. Alternatively – or additionally – their relationship with the bank. It is important to note that the interest rate is, for the most part, variable. This makes it hard to predict what the money you are borrowing will eventually cost you.
A loan and line of credit are two methods that individuals and businesses use to borrow from lenders. Loans have a non-revolving credit limit, meaning that the borrower has access only to the amount loaned once. Subsequently, they make principal and interest payments up until the debt is repaid.
A line of credit functions a little differently. The borrower receives a set credit limit – similar to a credit card – and performs regular payments consisting of both a principal and interest portion to pay it off. However, unlike a loan, the borrower has continuous and recurring access to the line of credit during its active period.
Approval for both lines of credit and loans primarily depends on a borrower’s financial history and credit rating. Moreover, their relationship with the lender is an important factor.
Revolving credit: what’s the difference?
Revolving credit and line of credit are both financing strategies. They are available to both individuals and businesses and provide borrowers with a level of flexibility. A lender brings funds – up to a specific credit limit anyway – that can be used and repaid at the borrower’s discretion. Similarities aside, revolving credit and lines of credit are quite different.
Revolving credit is an agreement allowing an account holder to borrow money again and again up to a set dollar limit. At the same time, they pay back a chunk of the current balance due in routine payments. Each payment, minus the fees and interest, restocks the available amount to the account holder.
Put simply, revolving credit remains open until the account’s closure by the borrower or lender. Contrarily, a non-revolving line of credit is a one-time arrangement. As soon as the credit line is paid off, the lender will officially close.
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