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A line of credit is a versatile financial tool provided by banks and other financial institutions. It's a type of arrangement where the lender offers a certain amount of credit to the borrower, but the borrower is not obliged to use the entire amount. Instead, they can borrow as much as they need, whenever they need it, up to the credit limit.
There are two main types of lines of credit:
The main features of a line of credit include flexibility in use, interest only on the amount used, and the ability to reuse the credit as it is repaid.
A line of credit and a term loan are both useful financing options, but they serve different purposes and have different terms.
A line of credit is more flexible. You can borrow up to a certain limit, repay the borrowed amount, and then borrow again. Interest is only charged on the amount you borrow, and not on the total credit limit.
On the other hand, a term loan is a lump sum of money that you borrow upfront and repay over a set period of time with interest. The interest is calculated on the total loan amount, regardless of how much of the loan you have spent.
The key difference lies in the flexibility and repayment structure. A line of credit offers more flexibility but may come with higher interest rates, while a term loan provides a fixed amount of money with a set repayment schedule.
Calculating the interest on a line of credit is relatively straightforward. You'll need to know the amount you've borrowed, the annual interest rate, and the amount of time you've had the borrowed money.
Here's how to do it:
Remember, you only pay interest on the amount you've borrowed, not on the total credit limit.
A line of credit is important for several reasons:
In simple terms, a line of credit is like a flexible loan from the bank. Think of it as a credit card with a higher limit. You can borrow money up to a certain limit, repay it, and then borrow again. You only pay interest on the amount you've borrowed. It's a handy tool for managing cash flow, covering unexpected expenses, or financing small projects.