Bank Line of Credit (LOC): Definition & How It Works

A “bank line” or a “line of credit” (LOC) is a kind of financing that is extended to an individual, corporationCorporate InformationLegal corporate information about Corporate Finance Institute (CFI). This page contains important legal information about CFI including registered address, tax number, business number, certificate of incorporation, company name, trademarks, legal counsel and accountant., or government entity, by a bank or other financial institution. This type of credit is different from term loans, such as housing mortgages or car loans. Usually, the borrowers of a LOC can access the funds at any time as long as the agreed credit limit is not exceeded, and timely minimum payments are diligently made.

It is also a type of revolving credit account, wherein the borrower can access the money, spend it, repay it, and then access it again. The bank or financial lender will charge interest as soon as money is borrowed, but only on the actual amount of funds accessed, not on the total line of credit. Bank approval for LOCsdepends on the borrower’s credit history, credit rating, and their prior business or personal relationship with the bank.

What are the Types of Bank Line?

1. Unsecured LOC

No collateral backs an unsecured loan, but a borrower must establish a good credit ratingCredit RatingA credit rating is an opinion of a particular credit agency regarding the ability and willingness an entity (government, business, or individual) to fulfill its financial obligations in completeness and within the established due dates. A credit rating also signifies the likelihood a debtor will default. and status to qualify. Small businesses with proven positive credit histories are more likely to get approved, but the amount of credit extended depends on various factors, such as revenue, expenses, established credit, and years in business.

2. Secured LOC

Property or other assets serve as the collateral for this LOC. In case of default on the loan payments, the lender has the ability to recover the money by selling the collateral it holds for the loan.

3. Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) is typically used for large purchases, such as home improvements. The amount of funds that can be borrowed under a HELOCHome Equity Line of Credit (HELOC) CalculatorThe Home Equity Line of Credit (HELOC) calculator can calculate the maximum line of credit available for a homeowner. A HELOC is similar to is based on a percentage of the appraised value of the home, less the amount still owed. There is a draw term, which means that funds can only be taken out during a set period of time.

4. Business LOC

A business LOC This is extended to clients who operate a business. Collateral is not often required, but banks are stringent on qualifications. Some financial institutions accept inventory and account receivables as collateral to back up the LOC.

5. Personal LOC

Extended to individuals, who can draw funds any time as long as the credit limit is not exceeded. In contrast to a credit cardCredit CardA credit card is a simple yet no-ordinary card that allows the owner to make purchases without bringing out any amount of cash. Instead, by using a credit, a personal line of credit usually charges a lower interest rate. There is no grace period or reward for early payment and no charge for cash advances.

What is the Purpose of a Bank Line?

In terms of flexibility and security, a bank line of credit can be helpful for businesses as well as for individuals who are in urgent need of ready cash.  One of the most typical uses of a line of credit with a financial institution is for working capital.

Funds are readily extended to business borrowers for settling obligations while their receivables are still pending collection. LOCs are often renewable on an annual basis.

What Situations are a Bank Line Useful In?

• Events or projects with funding challenges, such as weddings, funerals, birthdays, etc.
• Individuals who are self-employed or who work on commission who urgently need cash until they are paid for work already completed.
• Emergency situations, such as taxes, bill payments, or medical expenses.
• Overdraft protection for check users who are often in short supply of cash to fund their drawn checks.
• Buying or investing in business opportunities or promoting a business through advertising, marketing, or tradeshow participation.

More Learning

Thank you for reading CFI’s explanation of a bank line. For a career in finance, be sure to explore our Career Map and find the job that’s right for you! Earn a corporate finance certificateCertification ProgramsCheck out our Certification Programs for the most practical, hands-on, industry-relevant skills and training. And 100% online! and set yourself apart in a competitive job market.

CFI’s mission is to help you become a world-class financial analyst. With that goal in mind, the following resources will help you on your way:

• Revolving Debt FacilityRevolving Credit FacilityA revolving credit facility is a line of credit that is arranged between a bank and a business. It comes with an established maximum amount, and the
• Senior and Subordinated DebtSenior and Subordinated DebtIn order to understand senior and subordinated debt, we must first review the capital stack. Capital stack ranks the priority of different sources of financing. Senior and subordinated debt refer to their rank in a company's capital stack.  In the event of a liquidation, senior debt is paid out first
• Debt ScheduleDebt ScheduleA debt schedule lays out all of the debt a business has in a schedule based on its maturity and interest rate. In financial modeling, interest expense flows
• Financial Modeling Best PracticesFinancial ModelingFree financial modeling resources and guides to learn the most important concepts at your own pace. These articles will teach you financial modeling best practices with hundreds of examples, templates, guides, articles, and more. Learn what financial modeling is, how to build a model, Excel skills, tips and tricks