A line of credit is a borrowing option that gives you access to funds whenever you choose up to a predetermined credit limit. With some such arrangements, you access loan funds from a separate checking account. With others, you transfer funds into your checking account. An advantage to a line of credit compared to a traditional loan is that no interest is charged on the unused portion of the credit line.
Secured vs. Unsecured
Just as banks, credit unions and other lenders offer secured and unsecured traditional loans, most offer secured and unsecured lines of credit, or LOCs. While these may appear similar on the surface, they are distinctly different.
A home equity line of credit, or HELOC, is the most common example of a secured line of credit. Although less common, additional examples include a cash-backed LOC secured by a savings account or certificate of deposit or a car loan that affords you the chance to purchase a vehicle up to a certain amount from any car dealer.
A HELOC works differently than a cash-backed LOC. Unlike with a cash-backed LOC that has no loan expiration date and functions much like a credit card, HELOCs have expiration dates and usually feature a renewable or nonrenewable draw period and a repayment period.
During the draw period, you have free access to the LOC; during this time, you might be required to borrow a minimum amount each time you withdraw money or keep a minimum outstanding balance. Borrowing privileges end when the repayment period begins. Loan terms determine the repayment period. With some, the repayment period can extend for a number of years; with others, the LOC must be repaid much sooner.
An unsecured LOC, also known as a personal line of credit, is a revolving credit line. You can generally withdraw funds at any time and for any reason. As funds are repaid, you can continue tapping into the line of credit.
A disadvantage to a personal LOC is that eligibility requirements and interest rates are often higher than for a secured LOC. According to Brent Vallat, a Wells Fargo Bank executive, verifiable earnings, a solid credit history, a good to excellent credit score and a good relationship with the lender increase the chances for an approval.