Understanding Line of Credit (Explained in Plain English)

Banks often offer products to customers to further enrich the banking relationship or lure customers from competitors. Rates and other terms are the most common means by which a bank might go about attracting new customers. Other ways for a bank to market to new customers is by offering lines of credit or other loan products. A line of credit is a revolving account of credit for a customer to use at their discretion. The terms and approval process for a line of credit varies among different banks but all financial institutions require a strict credit approval process before extending a line of credit.

There are two main types of credit lines offered by a bank. One type of line of credit is unsecured; meaning that the amount of credit extended is not backed by corresponding collateral. Collateral can be property or any other asset that meets or exceeds the amount of credit extended through the credit line. An unsecured line of credit is usually available to those customers who have credit credentials of the highest order.

Customers who have less than stellar credit status can open a secured line of credit.  Secured lines of credit require the backing of collateral and often require the applicant to use their home to obtain the line of credit. Whatever the collateral, a default of the credit line puts the collateral at risk of possession by the bank.

The amount of the line of credit (credit limit) is determined by the credit approval process. In the case of the secured line, a determination regarding the value of the collateral figures chiefly in establishing the line of credit limit. Other factors that are considered include the other assets held by the applicant, the income of the applicant as well as the credit rating and employment stability.

Customers can use the line of credit in the same ways credit cards can be used. Some banks distribute checks to the account holder which can be written for purchases and drawn from the credit line directly. Repayment of the line of credit is determined by the balance on the account – the amount “changed” against the line of credit. The terms for repaying the outstanding balance and the interest rate applied will vary among banks and often vary based on the credit worthiness off the applicant. Consult the disclosure of terms before accepting or using the line of credit from your chosen bank.