A line of credit account is generally associated with a checking account that allows a business or individual to access to additional funds if needed. It works much in the same way credit cards do in that the amount of credit that can be tapped is pre-determined by the lending institution. The account holder can use as much as needed, whenever needed, up to the predetermined amount. These accounts, most commonly provided by banks, are often unsecured, though if credit requirements are not met, some institutions may require collateral.
In determining how much cash will be made available, the lending institution will take a number of factors into account, and the credit score of the individual or business is considered one of the most important. In addition, the balance between income and spending habits will be carefully scrutinized. The lender will want to make sure that there is enough income available to meet future payments on the line of credit. This is especially true when making a determination on a business line of credit. Unlike most individuals whose jobs generally have predictable incomes, a business may routinely operate with huge swings in cash flow.
Fluctuations in cash flow are one of the most common reasons a business might need a line of credit account. For instance, if an evaluation of profits presents a trend that indicates the business makes most of its yearly income during a specific season, it may need to draw against a line of credit account to float the business through the months when profits are down. As long as the profitable periods are sufficient to cover the debt, a line of credit account is typically an effective and reasonably safe way to address ordinary cash flow interruptions.
One of the most attractive elements to a line of credit account is that interest is charged based on the amount used. This works much better than a traditional loan, where interest is charged on the full amount borrowed. Another potential money-saving aspect is that a line of credit usually does not have any set interest rates. The rates are set so that they fluctuate and are determined by current market conditions.
Though a line of credit account is usually associated with businesses, individuals may find them useful as well. In real terms, overdraft protection for a personal checking account is actually a type of credit line. Many people use lines of credit to help fund large projects such as building a new home or renovating an existing one.