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What’s involved with a line of credit?

Often, when huge financial bills hit at once, most people and business owners are unprepared to come up with the needed funds. For example, perhaps you’re suddenly faced with unexpected medical bills at the same time you’re building a house or planning a wedding for your daughter. That’s when it helps to have a line of credit. Here’s what’s involved in a line of credit and how it differs from a revolving line of credit.

What Exactly Is a Line of Credit?

Simply put, a line of credit is a financial plan for undertaking unpredictable, exceptionally large expenses. Also known as a credit limit or credit line, a line of credit gives borrowers the maximum amount of money that a bank is willing to lend a person or business without needing more approval. For instance, often small business owners use a line of credit to take out more than one loan, such as for upgrading their facilities or buying equipment, rather than having to apply and be approved for each individual loan.

Unlike a traditional loan, a line of credit doesn’t give an individual or business owner one huge lump of money. It’s very similar to a credit card because you’re able to use credit when there’s a need for paying for items that are impossible to pay for at the time you buy them. However, the interest rates involved on most lines of credit are low, which is not the case for most credit cards. Also, the limits are generally high.

What is a Revolving Line of Credit?

A revolving line of credit is a type of line of credit. Also called “revolving account”, revolving credit is a term referring to a credit report account that has a credit limit that’s determined by a lender. Just as a line of credit, a revolving line of credit is a financial agreement that’s between an individual or business and a lending firm.

In a revolving line of credit, you’re allowed to decide the amount that will be charged that’s within that limit, besides the amount you’ll have to pay off each month. It works similarly to a credit card. A common example of revolving credit is an HELOC (home equity line of credit). It helps to have one or more credit card accounts that are in good standing as this can serve as proof that you’re a good credit risk. Just remember that you can only charge the amount that you’re able to repay in full each month.

When you have revolving credit, you have the choice of either carrying your balance over from one month to the next month or paying off the balance in full at the close of a billing cycle. When a balance is carried over from one month to the next one, it’s known as “resolving” the balance.

A Line of Credit vs. Revolving Credit

Although a line of credit is very similar to revolving credit, there’s one primary difference. Unlike a revolving line of credit, a line of credit doesn’t replenish once payments have been made. This means that after a borrower has paid down a line of credit, the account is closed, so it can’t be reopened. In order to receive more credit, an individual or business has to reapply for an entirely new line of credit. The odds of obtaining additional credit are considerably better when the initial loan was used wisely.

Considerations and Warnings

  • Frequently, corporations and small businesses use a revolving line of credit to protect them from cash flow issues or for financing capital expansion.
  • Both revolving and non-revolving credit are available in two versions: secured and unsecured credit.
  • While a secured credit line involves using collateral, such as a home, car or other assets for securing a loan, an unsecured line of credit doesn’t require collateral.
  • Although an unsecured loan involves less paperwork and is quicker, it can be more difficult to obtain as you’ll need to have a better credit score since your loan won’t have collateral as security.

Do you need a personal loan or a business loan? Don’t hesitate to call Jim Plack. As a credit and lending expert, I have more than 25 years of experience, working in the banking and lending industry. Please contact us and find out more about our wide range of services.