Line of Credit (LOC)
What it is:
A line of credit (LOC) is an arranged amount of standing credit that a bank's customer may draw upon at any time.
How it works (Example):
An LOC is a standing amount of money, similar to a loan, that a bank extends to a customer. A customer may draw upon the available line of credit, provided that the amount does not exceed the limit. Money borrowed on the line of credit must be paid back within a specified timeframe, at a specified interest rate. Unlike a loan, however, only the money actually drawn (or used) on a line of credit is charged interest. For instance, if someone has a $20k line of credit from his bank, but draws only $5k, he will be changed interest on only the $5k.
Why it Matters:
An LOC can be a convenient source of funds in an emergency. It is advisable to explore other borrowing options as lines of credit are unsecured, meaning that the interest rate charged varies with movements in banks rates. This can result in the borrower paying very high interest relative to the amount borrowed.