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What Is a Line of Credit? Definition, Types & How It Works
A line of credit is a form of borrowing that allows you to access funds up to an approved limit, repay the amount used and borrow again as needed. According to the Federal Reserve Banks’ 2025 Small Business Credit Survey, 43% of firms that applied for a loan, line of credit or merchant cash advance in the previous 12 months had applied for a business line of credit [1].
Understanding how a line of credit works is particularly important if you run a business or want to manage your finances effectively. Unlike a term loan, which generally provides a lump sum upfront, a line of credit allows you to draw funds when you need them, subject to the terms of the agreement. This guide explains what a line of credit is, how it works, its main benefits and risks, and how to qualify for and manage one.
What Is a Line of Credit and How Does It Work?
A line of credit is a financing facility that allows borrowers to access funds up to a maximum approved amount. It works in a similar way to a credit card in that borrowers can draw funds, repay the amount used and access the available credit again. However, interest rates, credit limits, repayment terms and fees vary by lender and product.
Interest is generally charged on the amount borrowed rather than the unused portion of the credit limit, although some facilities may include commitment fees, maintenance charges or other costs.
The process is relatively straightforward. A lender assesses the applicant's creditworthiness and financial position before approving a credit limit. For business applicants, this assessment may include credit history, revenue, cash flow, time in operation and, where applicable, collateral.
Once approved, the borrower can draw down any amount within the available limit, subject to the facility's terms. Repaying the amount borrowed generally restores the corresponding portion of the available credit. This makes a revolving line of credit different from a conventional term loan, which usually provides a fixed sum that is repaid according to an agreed schedule.
According to the Federal Reserve Banks’ 2025 Small Business Credit Survey, 54% of firms applying for financing at small banks received full approval, making small banks a notable source of business financing for eligible applicants [1]. However, this figure covers the survey's broader category of financing applications, rather than business lines of credit alone.
Secured vs Unsecured Lines of Credit: Key Differences
One of the most important distinctions when choosing a line of credit is whether it is secured or unsecured. This affects the lender's risk assessment, the application requirements and the potential consequences of default.
Feature | Secured line of credit | Unsecured line of credit |
Collateral required | Requires assets to be pledged as security | Generally does not require specific physical assets as collateral |
Interest rates | May offer more favourable rates, depending on the lender and borrower | May carry higher rates because the lender has fewer assets available as security |
Approval requirements | Assessment may include collateral value and the borrower's creditworthiness | Greater emphasis may be placed on creditworthiness, cash flow and financial records |
Credit limits | May allow higher limits when sufficient eligible collateral is available | Limits may be lower, depending on the borrower's financial position |
Risk if the borrower defaults | Pledged assets may be subject to enforcement | Personal guarantees or other contractual obligations may expose the borrower or its assets to liability |
These differences are general tendencies rather than guarantees. Interest rates, credit limits and approval requirements depend on the lender, the borrower's qualifications, the facility's structure and the security offered.
For example, the Federal Reserve Bank of Kansas City's Small Business Lending Survey reported median interest rates on new lines of credit at participating banks ranging from 7.25% to 8.17% in the first quarter of 2025, depending on the bank's location and whether the rate was fixed or variable [2]. These figures reflect reported rates for a particular period and sample of banks, not the rates every borrower can expect to receive.
Business Line of Credit vs Personal Line of Credit
Understanding a line of credit also means recognising that different facilities serve different purposes.
A business line of credit is designed to finance business activities. Depending on the lender, approval may be based on the company's revenue, cash flow, operating history and business credit profile. Funds may be used for working capital, inventory purchases, short-term operating expenses or other eligible business needs.
A personal line of credit, by contrast, is intended for an individual's personal borrowing needs. The lender generally assesses the applicant's personal income, credit history, existing debts and overall financial position.
Keeping business and personal finances separate can make financial management and record-keeping easier. It can also help establish a distinct business credit history over time. However, a lender may still require a personal guarantee or assess the owner's personal credit when evaluating a business application, particularly if the company is new or has a limited credit history.
Key Benefits of Using a Line of Credit
A line of credit offers several potential advantages, particularly for businesses with recurring short-term financing needs.
- Flexibility: Borrowers can access funds when required, up to the approved limit, rather than taking out a full loan amount upfront.
- Interest costs: Interest is generally charged on the amount drawn rather than the entire available credit limit, although additional fees may apply.
- Cash flow management: A line of credit can help cover temporary cash flow gaps caused by seasonal fluctuations, delayed customer payments or unexpected operating expenses.
- Reusable capital: Repaying the amount borrowed generally restores the available credit, allowing the borrower to draw funds again without submitting a new application for each withdrawal.
- Access to funds: Once the facility is established, borrowers can usually access funds according to the agreed terms, making it easier to respond to short-term financing needs.
Despite these advantages, a line of credit is not a substitute for sound financial management. Borrowing costs, repayment obligations and the risk of relying on revolving debt should all be considered before drawing funds.
How to Qualify for a Line of Credit
Lenders assess applications according to their own eligibility criteria, which vary by product and borrower. The following factors commonly influence decisions.
1. Credit score
A stronger credit profile can improve the chances of approval and access to more favourable terms. Requirements vary considerably by lender. For example, some online lenders featured in NerdWallet's review of unsecured business lines of credit accept applicants with credit scores around 600, while some traditional banks may require scores in the high 600s or higher [3]. These are examples from specific lending products, not universal requirements.
2. Time in business
Lenders may consider how long the business has been operating. An established trading history can provide evidence of financial stability, while newer businesses may face more restrictive eligibility criteria.
3. Annual revenue
Some lenders set minimum annual revenue requirements to assess whether a business can support the repayments. The thresholds vary by lender, product and credit limit.
4. Financial documentation
Prepare relevant financial records before applying. These may include bank statements, tax returns, balance sheets, profit and loss statements, cash flow forecasts and accounts receivable ageing reports. The documents required depend on the lender's underwriting process.
5. Existing debt and repayment capacity
Lenders may examine existing borrowing, debt obligations and the cash flow available to service additional debt. For businesses, the assessment often focuses on whether operating cash flow is sufficient to meet repayment obligations. Personal lines of credit may also be assessed using the applicant's debt-to-income ratio.
Preparing these documents in advance can help streamline the application process and give lenders a clearer picture of the business's financial position.
Line of Credit vs Term Loan: Key Differences
A common question when comparing financing options is whether a line of credit or a term loan is more suitable. The answer depends on the purpose of the borrowing and the timing of the business's funding needs.
A term loan generally provides a lump sum that is repaid according to a predetermined schedule. It is often suitable for a defined expenditure, such as purchasing equipment, expanding premises or funding a specific investment.
A line of credit provides access to an approved borrowing limit and allows funds to be drawn as needed. Repayments generally restore the available credit, making it useful for recurring or unpredictable short-term cash flow requirements.
The key differences are summarised below.
Feature | Line of credit | Term loan |
Access to funds | Draw funds as needed, up to the available limit | Usually receive a lump sum upfront |
Repayment | Depends on the facility; repaid amounts may become available again | Generally follows an agreed repayment schedule |
Interest | Usually charged on the amount drawn | Usually calculated according to the loan's outstanding balance and terms |
Typical use | Working capital and recurring cash flow gaps | Defined purchases and longer-term investments |
Flexibility | Generally offers greater flexibility for repeated borrowing | Generally less flexible once the loan has been disbursed |
Neither option is automatically better. A line of credit may suit fluctuating working capital requirements, while a term loan may be more appropriate when a business needs a specific amount of funding for a clearly defined purpose.
Best Practices for Managing Your Credit Facility
Once you have access to a line of credit, effective management can help you obtain its benefits without creating unnecessary financial pressure.
First, track every withdrawal, repayment, interest charge and fee. Maintain accurate records so that you always know how much credit remains available and how much you owe.
Second, use the facility for appropriate purposes. Short-term working capital needs, inventory purchases and temporary cash flow gaps may be suitable uses. Relying on revolving credit to finance long-term projects that take years to generate returns can create repayment difficulties if the borrowing costs accumulate before the investment produces sufficient cash flow.
Third, monitor credit utilisation, which measures the proportion of the available credit limit that has been drawn. High utilisation can indicate financial pressure and may influence some lenders' assessments, although its significance varies by credit product and scoring model.
Fourth, arrange reminders or automatic payments where appropriate to reduce the risk of missing a payment. Check the repayment terms carefully, as late payments may result in additional charges or other consequences under the agreement.
Finally, review your credit limit periodically. If your business's financing needs change, discuss possible adjustments with your lender. Any increase remains subject to the lender's assessment and approval.
A well-managed line of credit should support the business's cash flow rather than become a permanent substitute for sustainable revenue and adequate working capital.
Frequently Asked Questions
1. What is a line of credit, and how is it different from a loan?
A line of credit allows you to borrow up to an approved limit, repay the amount used and borrow again as funds become available. A term loan generally provides a fixed lump sum that is repaid according to an agreed schedule. A line of credit typically charges interest on the amount drawn, although fees and pricing structures vary.
2. What factors do lenders consider when reviewing a business line of credit application?
Lenders may consider the business's financial performance, cash flow, credit history, existing debts, time in operation and available collateral. The specific requirements depend on the lender, the credit product and the amount requested.
3. How much does a line of credit cost?
The cost depends on the interest rate, credit profile, collateral, fees and other contractual terms. Interest is generally charged on the amount drawn, but some facilities also include arrangement fees, maintenance charges or other costs. Review the full agreement to understand the total cost of borrowing.
4. Can I obtain a line of credit without collateral?
Yes. Unsecured lines of credit generally do not require specific physical assets to be pledged as security. However, they may have higher interest rates or lower credit limits than comparable secured facilities. Lenders may also require a stronger credit profile or a personal guarantee.
5. How long does it take to obtain approval for a line of credit?
Approval times vary according to the lender, the complexity of the application and the information required for assessment. Some online lenders may process applications relatively quickly, while traditional lenders may require additional documentation and a more extensive review. Providing complete and accurate financial records can help reduce delays.
Conclusion
A line of credit is a flexible financing facility that allows borrowers to access funds up to an approved limit, repay the amount used and draw funds again under the terms of the agreement.
Its main characteristics include revolving access to funds, secured and unsecured structures, interest and fee considerations, and lender-specific eligibility requirements. For businesses, it can help manage working capital and short-term cash flow gaps when used responsibly.
Before applying, compare interest rates, fees, repayment conditions and eligibility requirements. Choosing a facility that matches your business's cash flow and borrowing needs can help you manage short-term financing without taking on unnecessary financial risk.
This article is intended for informational purposes only and does not constitute legal, financial, investment, or other professional advice, nor does it constitute a recommendation of any product or service. This article should not be regarded as constituting an offer or a solicitation to buy or sell any regulated or financial products or services. It has not been reviewed by any regulatory authority in any jurisdiction. Bettr makes no representations or warranties regarding the accuracy, completeness, or applicability of the content, and readers are encouraged to consult with legal, financial, or other professionals for advice tailored to their specific situation. Bettr does not guarantee the accuracy and completeness of this article and expressly disclaims any and all liability to any person in respect of the consequences of anything done or omitted to be done wholly or partly in reliance on this article.
1. https://www.fedsmallbusiness.org/reports/survey/2025/2025-report-on-employer-firms
3. https://www.nerdwallet.com/business/loans/best/unsecured-business-line-of-credit