Overview
A line of credit (LOC) gives you flexible access to cash up to a set limit. Unlike a one‑time loan, you borrow as needed and generally repay interest only on the outstanding balance. LOCs work for short‑term cash flow, planned projects, or as a financial safety net when used responsibly.
How a line of credit works
- Lender sets a credit limit and terms based on credit score, income, and collateral (if any).
- You can draw funds up to that limit during the draw period, then repay and redraw (revolving credit).
- Interest is charged on the amount you actually borrow. Repayment terms vary: some LOCs require interest‑only payments during the draw period; others require principal plus interest.
Common types
- Personal (unsecured) LOC: typically smaller limits and higher interest than secured options.
- Home Equity Line of Credit (HELOC): secured by your home, usually offers lower rates but uses your home as collateral. See our guides on Using a HELOC for Emergency Expenses: Risks and Alternatives and HELOC Reset Strategies: When to Convert to a Fixed‑Rate Loan.
- Business line of credit: supports operating cash flow, seasonal inventory, or short‑term working capital needs.
When to use a line of credit
- Bridge short gaps in cash flow (payroll, slow receivables).
- Fund staged projects (home renovation draws with a HELOC).
- Cover emergencies when you don’t want to sell long‑term assets.
When not to use one
- For ongoing everyday spending without a clear repayment plan.
- To finance depreciating purchases you can’t afford over time.
Real‑world example
A small business owner I advised used a $50,000 business LOC to buy seasonal inventory and repay the balance after peak sales. Because draws matched predictable revenue, interest costs stayed low and the business avoided high‑cost short‑term loans.
Advantages
- Flexibility: borrow only what you need.
- Cost efficiency: interest only on used funds (often lower than credit cards).
- Revolving access: repay and redraw without reapplying during the term.
Drawbacks and risks
- Variable interest: many LOCs (including most HELOCs) have variable rates that can rise.
- Secured LOCs risk your collateral (e.g., a HELOC can put your home at risk).
- Temptation to over‑borrow can lead to persistent high balances and interest costs.
How to use a line of credit wisely — practical rules
- Treat it like a short‑term tool. Use LOCs for time‑bound needs you can repay in months, not as a safety net for permanent expenses.
- Build a repayment plan before you draw. Know how and when you’ll repay principal and interest. In my practice, borrowers who set automatic payments cut interest costs and avoid missed payments.
- Understand the fees and terms. Check for annual fees, draw fees, minimum payments, prepayment penalties, and whether the rate is fixed or variable. The Consumer Financial Protection Bureau has a clear primer on LOCs you can review for basics (consumerfinance.gov).
- Limit your buffer. Keep a smaller unused cushion instead of maxing out the LOC; this reduces temptation and interest exposure.
- Monitor interest rate risk. If your LOC has a variable rate and your balance is long‑term, consider converting to a fixed‑rate loan.
- Use secured LOCs (like HELOCs) only when benefits outweigh the risk of losing your collateral.
Common mistakes to avoid
- Using a LOC for sustained living expenses without income to repay it.
- Ignoring variable rate risk on long balances.
- Overlooking fees such as appraisal, origination, or inactivity charges.
Short FAQs
- How is a line of credit different from a credit card? A LOC typically has lower rates and lets you borrow larger sums for specific needs; credit cards are revolving but generally have higher rates and are designed for ongoing consumer purchases.
- Can I use a HELOC for any purpose? Usually yes, but after the 2017 tax changes, interest deductibility may be limited—consult a tax advisor or the IRS for your situation.
Authoritative sources and further reading
- Consumer Financial Protection Bureau: What is a line of credit? (consumerfinance.gov)
- Investopedia: Line of Credit
Internal resources
- Using a HELOC for Emergency Expenses: Risks and Alternatives: https://finhelp.io/glossary/using-a-heloc-for-emergency-expenses-risks-and-alternatives/
- HELOC Reset Strategies: When to Convert to a Fixed‑Rate Loan: https://finhelp.io/glossary/heloc-reset-strategies-when-to-convert-to-a-fixed-rate-loan/
Disclaimer
This article is educational and not personalized financial advice. For recommendations tailored to your situation, consult a certified financial planner, tax advisor, or lender.
Author note
I’ve worked with consumers and small businesses for over 15 years. In practice, disciplined repayment plans and clear use cases separate LOCs that help financial health from those that create persistent debt.
