How Does a Line of Credit Work?
Written by True Tamplin, BSc, CEPF®
Updated on June 21, 2021
A line of credit works by allowing you to borrow funds from a revolving pool.
You can spend the funds continuously so long as you continue making minimum payments and paying down the balance.
Unlike a loan, with a line of credit you only pay interest on funds that you spend.
How Does a Checking Line of Credit Work?
A checking, or overdraft, line of credit is a line of credit attached to your checking account to protect against overdraft charges.
An overdraft LOC allows you to only be charged interest on the overdrawn amount, rather than the high overdraft fees you would normally incur.
How Does a Line of Credit Work FAQs
Line of Credit (LOC) Definition
What Is a Line of Credit and How Does it Work? Revolving vs Non-Revolving
Lines of credit will either remain open, or will close, once the loan has been repaid.
Revolving lines of credit are considered “revolving”because an individual’s credit is replenished when some or all of the outstanding debt has been paid off.
In contrast, a non-revolving line of credit is closed once the account is fully paid off, such as a student loan or mortgage.
Non-revolving credit usually has a lower interest rate.
How does a Line of Credit Work? Secured vs Unsecured
A home equity loan is an example of a collateralized loan, whereby the home is the collateral and will be claimed by the creditor in the event of a default on the loan.
Credit card loans are almost always unsecured, which causes creditors to take on more risk and is why credit card interest rates are generally higher and the borrowing limits are generally lower than secured loans.