What is a line of credit: A simple guide
A line of credit is a flexible and convenient way to borrow and repay money over time. Learn more about lines of credit, how they work, and if one might be the right option for you.
Updated 
13 min. read
Sometimes you just need a little extra cash. Maybe you’re finally tackling a home renovation project, consolidating some high-interest debt, or thinking about going back to school. No matter the reason, a line of credit may be able to help you achieve your goals.
A line of credit, also called a credit line, is a flexible and convenient way to borrow money. It’s basically an account that allows you to tap into funds when you need them. And unlike a traditional loan, you only pay interest on the actual amount you borrow.
How do lines of credit work?
A line of credit is a form of revolving credit that lets you borrow money when you need it, up to a predetermined amount. But how does it actually work? Let’s break down the process.
Fill out an application: Bankers will help make it quick and easy to apply, and you can potentially get your money in a couple of days. You’ll need a form of identification with your current address, and your banker will review your credit history.
Borrow funds when you need them: You can transfer funds from your line of credit account to a checking account on your phone, online, in person at a branch, or with checks. You can borrow up to a predetermined limit set by your lender and use the funds however you need.
Make your repayments: After you use money from your line of credit, you’ll need to pay it back along with any interest. You’ll only pay interest on the money you borrow, and you won’t make any payments until you use your credit line. You can make repayments online, by mail, at a branch, or through your checking account.
Borrow again as needed: One of the convenient aspects of a line of credit is that you can borrow again and again. Once you pay down your line of credit, you replenish your available credit and that money will be available to tap into again when you need it (without having to reapply).
When it comes to how much interest you actually pay, it’s important to keep in mind that lines of credit come with variable rates of interest. That means your rate can change over the life of your loan. However, there is a cap on how much the rate can change each time and how much the rate can change during the life of your loan.
Lines of credit vs loans
You might be wondering — how is this any different from a loan? The main difference is how you’ll get the money you’re borrowing.
With a loan, you receive an installment. That means you’ll get all the money that you’re borrowing up front. If you’re borrowing $3,000, for example, then you’ll get a one-time lump sum of $3,000.
A line of credit is different. Credit lines are revolving, which means you only withdraw the amount you need, when you need it. You don’t have to make payments or pay interest until you use the funds. This can make them a more flexible, and sometimes more affordable, option.
The way you repay loans vs. lines of credit is also different. With a loan, you’ll need to make regular payments with interest toward the entire loan balance. You’ll continue making payments until the entire loan balance (plus interest) is paid off.
But with a line of credit, you don’t need to make any repayments until you actually use the funds. Once you do tap into your credit line, you can repay the funds immediately or over a set time. And, unlike a loan, you’ll only pay interest on the amount you actually used, not the entire amount you’re able to borrow.
Type of lines of credit
There are several types of lines of credit you can choose from, including:
Personal line of credit
In general, there are two types of personal lines of credit: secured and unsecured.
Unsecured line of credit: A personal line of credit is typically unsecured. That means your lender is trusting you to make your repayments after reviewing your finances, debts, and credit history. With an unsecured line of credit, you don’t need to put down any form of collateral and you’re not borrowing against anything (like the value of your house or a car). These are slightly riskier for your lender, so these types of credit lines may come with a higher interest rate.
Secured line of credit: On the other hand, a secured line of credit does require you to use a personal asset as collateral, which can be seized by your lender if you don’t repay it. For example, if you are getting a home equity line of credit (see below), your collateral is your home. Since these are seen as less risky for lenders, they often come with lower interest rates.
Learn more about secured and unsecured lines of credit.
Home equity lines of credit
A home equity line of credit, commonly known as a HELOC, is an example of a secured line of credit. With a HELOC, you’re borrowing money against the equity you’ve built up in your home and using your house as collateral. HELOCs tend to have lower interest rates because they’re secured, making them a popular option for homeowners.
Fixed rate lock option: A fixed rate lock option, also known as an FRLO, allows you to lock in a fixed rate on your HELOC. You can lock in a fixed rate at any point during the draw period at terms of 5 to 20 years. An FRLO is an attractive option for people who prefer the security of knowing their payments won’t change during the draw period, which can be particularly desirable in a rising rate environment. If you change your mind at any time, you can always go back to a variable rate HELOC without having to refinance.
Learn more with this article about home equity lines of credit.
Pros and cons of a line of credit
What are the pros and cons of a line of credit? Like all lending options, an unsecured or secured line of credit come with benefits and things to consider.
| Advantages of a line of credit | Disadvantages of a line of credit |
|---|---|
| Flexibility. Only withdraw money when you need it. | An unsecured line of credit may have higher interest rates than other options. |
| No interest payments until you actually tap into your funds. After that, only pay interest on what you use. | Both kinds may have lower credit limits than traditional loans. |
| Use your funds for a variety of needs. | Like with all borrowing options, you’ll be responsible for paying back any funds you borrow. |
| A HELOC tends to have lower interest rates and are a popular option for homeowners. | Some lines of credit come with an annual registration or administration fee, so it’s helpful to ask your financial institution about any that are associated with getting one. |
So how do lines of credit stack up to other lending options? Here are a few key differences between lines of credit compared to credit cards and loans, so you can find the option that’s right for you.
Line of Credit | Credit Card | Loan | |
|---|---|---|---|
Type of credit | Revolving | Revolving | Installment (lump sum) |
Monthly payment | Variable | Variable | Fixed |
Interest payments | Only pay interest on money you borrow | Only pay interest on money you borrow | Pay interest on the entire amount, spread out across payments |
Secured or unsecured? | Typically unsecured (unless it’s a HELOC) | Can be both | Unsecured |
Life of loan | Up to 15 years | No end date | 24 to 60 months |
If you’re still unsure if you’d benefit from a line of credit, here are a few scenarios where it may be worth it.
- You need cash, but you aren’t sure how much. Say you want to redo your kitchen but aren’t sure the exact amount it will cost. In this scenario, a line of credit might be a better fit than a loan, because you’d only need to repay what you actually end up using.
- You’re looking for a lower interest rate. If you need to borrow money but don’t want to get stuck with a high interest rate, you may want to consider a line of credit. They typically have lower rates than other forms of borrowing, like credit cards.
- You want more flexibility. Maybe you need to spend money on a few different things. Or maybe you want to spread out your spending over time. A line of credit works for a variety of situations, because you control what you borrow and when.
- You’re looking for ways to build credit history. Making timely payments on a line of credit is one way to help boost your credit score and show lenders that you’re a reliable borrower. This can help you secure larger loans in the future, like a mortgage.
What can a line of credit be used for?
You can use your line of credit for any purpose, though many borrowers use them to help with a cash flow crunch or to fund a project with a fluctuating budget. Here are a few of the most common reasons to use a line of credit:
- Home improvements: Repairs and renovations are a great way to add value to your home but can be difficult to budget for and come with surprise expenses, which makes a line of credit a great option for flexible spending.
- Consolidate debt: If you have several types of debt (like loans or high-interest credit cards), you can streamline the repayment process by consolidating with a line of credit. That way, you’ll have one monthly payment and one interest rate.
- An emergency fund: A line of credit makes a great safety net since you don’t need to make payments unless you use the funds.
- Personal expenses: A new car, college tuition and/or medical expenses — no matter your need, a line of credit it is a great option.
How to qualify for a line of credit
When you apply for a line of credit, a BMO banker will request all the necessary information from you. This typically includes your credit history, employment and income information, as well as outstanding debts. If you are applying for a HELOC, you will also need to provide information about your property.
Once your banker has everything they need, they will review and determine if you are eligible for a line of credit.
Keep in mind that one of the main requirements for a successful application is having a positive credit score. The quality of your credit history can affect whether or not you get approved and what interest rate you are eligible for.
If you need help building your credit history or improving your score, you might want to try our Credit Builder Loan Program or find resources to help create more financial stability from our partner SpringFour.
Ready to get started? Explore a line of credit with BMO. To apply, you’ll need to call or visit a branch. Make sure to bring personal identification with your current address, and we’ll walk you through the rest.
Lines of credit FAQs
This depends on a lot of factors, like your financial situation, credit history, and how you plan to use your line of credit. While everyone’s different, there are a few situations where a line of credit can be beneficial — if you’re looking for a convenient, flexible way to consolidate debt, build credit history, or pay for big expenses like school tuition. It can also act as a safety net if you don’t have another type of emergency fund. Its low cost of borrowing makes it a great option over a cash-out mortgage refinance, especially when interest rates start to rise.
There are some important differences between a loan and a line of credit. With a loan, you’ll receive a one-time lump sum for the total amount you’re borrowing. With a line of credit, you only withdraw the amount you need, when you need it.
With a loan, you’ll need to make regular payments with interest until the entire loan balance (plus interest) is paid off. With a line of credit, you don’t need to make any repayments or any interest payments until you use the funds.
The main difference between a line of credit and a credit card is the way you use them. A credit card is intended for everyday use on an ongoing basis, while a line of credit comes with set periods for withdrawal and repayment.
With a credit card, you use your physical card or credit card number to make purchases. With a line of credit, you can use your borrowed funds by transferring money from your loan account directly into a checking account. Also, the interest rates on lines of credit tend to be lower than credit cards.
Not sure which option is right for you? We can help you choose
You can lock in a fixed rate on some or all of your HELOC with a fixed rate lock option (FRLO) at any time during the draw period to pay down your balance with payments that will not change. Your rate will be locked in for the amount of time you choose, with terms ranging from 5 to 20 years. As the fixed rate balance is paid down, the principal amount paid off becomes available for use again as part of the credit line.
You can lock in up to 3 advances at a time. There is no fee if you lock your rate at closing, but there is a $75 fee for each lock you place thereafter. If you change your mind at any time, you can always go back to a variable rate HELOC without having to refinance. footnote 1
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Find out more about how a line of credit with BMO can help you achieve your goals.
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Footnote 1 details. Fixed Rate Lock Option Information The minimum line of credit withdrawn from a HELOC that can be converted to a fixed rate loan is $2,000 and the maximum that can be converted is 100% of the line amount. The minimum term is 5 years and the maximum loan term is 30 years. 30-year term only available at time of origination. No more than three fixed rate lock options may be open at one time. A $75 fee applies each time you convert a fixed rate lock option after the date of origination. Minimum payment due on a fixed rate lock option includes principal and interest in fixed monthly payments. As the fixed-rate balance is paid down during the draw period, funds are replenished and available for use at the variable rate during the draw period.