A credit arrangement in which a financial institution agrees to lend money to a borrower up to a specified limit. The borrower can draw down on the line of credit at any time, as long as he or she does not exceed the maximum set in the agreement and meets all other covenants of the agreement.
A line of credit works in a similar fashion a credit card. The borrower only pays interest on the amount drawn, not the total limit, and may then pay off all or part of the balance and continues to pay interest only on the amount outstanding. For example, if the borrower drew down $10,000 during the first month and the line of credit carried an interest rate of 4.0%, then the borrower would owe $33.33 in interest for the month (calculated by multiplying the $10,000 balance by the 4.0% interest rate divided by 12 months). If in the second month the investor repaid $4,000, leaving an outstanding balance of $6,000, then that monthly payment would be $20.00 ($6,000 balance times 4.0% interest rate divided by 12 months).