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All You Need to Know About a Line of Credit

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Last updated on June 22, 2022 Comments: 15

Everyone is familiar with car loans and credit cards. But despite being the most common form of consumer debt in Canada, lines of credit aren’t as widely understood. What exactly is a line of credit and why are they so popular? We have all the answers, including a breakdown of the various types available, how they work, why you might want one, and how to get one.

The Basics

A line of credit (LOC) is an open-ended loan that lets you borrow money at any time, up to a predetermined limit. Once you have one, you can borrow, repay and borrow again up to your credit limit without having to reapply. And you are free to use the money for any purpose you choose.

Unlike a personal loan, there is no set schedule to repay the money you borrow from a line of credit. However, you must make monthly interest payments on any amount you borrow, as interest begins to accrue from the very first day you borrow the money until the day you pay it back.

How Does a Line of Credit Work?

It might help to think of a line of credit as a bucket of Loonies that you draw from. The bucket has a set capacity, say 1,000 Loonies. You can borrow however many Loonies you want — $1, $10, $100, or the entire bucket of $1,000 — whenever you want, and you will pay interest only on the number of coins you have out at any given time. You can refill the bucket as often or as infrequently as you want. But once that bucket’s empty, you won’t be able to borrow any more Loonies until you start refilling it.

You can set up a line of credit with a bank, credit union, or other financial institution, which will determine your credit limit and variable rate of interest. Once approved you can access your available credit whenever you like by ATM, cheque, or online banking, so long as you keep your account in good standing by making your interest payments on time.

How to Use a Line of Credit

How to Use a Line of Credit

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Here are some common reasons why you might opt to take out an LOC:

Types of LOCs: Secured and Unsecured Line of Credit

LOCs come in two basic varieties: secured and unsecured.

With a secured line of credit, borrowers use a high value asset that they own, usually a home, as collateral against the loan. Lenders can feel confident that even if a borrower defaults on his or her payments, they can still recover the value of the loan by taking possession of that collateral asset. Because of this reduced risk to lenders, they will usually offer better interest rates on secured lines of credit than on unsecured ones.

An unsecured line of credit has no asset of value underwriting the loan, which also makes it harder for borrowers to qualify for. The most common unsecured lines of credit are personal and student lines of credit, while the most common secured LOCs are home equity lines of credit (HELOCs).

Personal Line of Credit

This is the most basic line of credit available to Canadians. Because it is unsecured, there is no risk that borrowers will lose their home or other collateral asset if they default on payments. Instead, it’s the lender that holds most of the risk, so interest rates aren’t as favourable as those on a secured line of credit.

Having said that, the rates offered on personal lines of credit are still usually lower than for credit cards, personal loans, or other short-term loans. As such, borrowers commonly use personal lines of credit for consolidating higher-interest rate loans or for unexpected expenses.

Student Line of Credit

Similar to a personal line of credit, a student line of credit is unsecured, but is only available to part-time or full-time students enrolled in a recognized post-secondary education institution. The money borrowed from a student line of credit can be used for tuition, books, housing, and other living expenses, such as food and transportation.

Unlike with student loans, money borrowed from a student line of credit starts accumulating interest immediately, even if the borrower is still studying. The borrower doesn’t have to start repaying the loan, however, until after they graduate (there may be a grace period of six to 12 months, depending on the repayment terms of the lending financial institution). If they choose, students can start paying the money back sooner — even while they’re still studying — without penalty.

Home Equity Line of Credit (HELOC)

Home Equity Line of Credit

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As a secured line of credit, a HELOC offers relatively low interest rates, usually somewhere around 0.5% to 2% above the lender’s prime rate. To qualify, borrowers typically must own a home with at least 20% equity — meaning that any balance on the mortgage is less than 80% of the home’s value.

The credit limits on HELOCs are often higher than other types of loans or lines of credit, as they can go up to 65% of the home’s purchase price or market value. With the average home price in Canada hovering close to $500,000, that means a typical Canadian homeowner with 20% equity could have access to a HELOC with a $320,000 credit limit. Because of these larger limits and low interest rates, borrowers commonly use HELOCs to finance major expenses, such as home renovations, or to access funds for investment. A HELOC can also be used as a substitute for a mortgage (if your down payment or equity is at least 35% of the home’s purchase price/market value), or can be combined with a mortgage, which is also called a readvanceable mortgage.

Your mortgage lender will most likely offer some form of a HELOC, but it’s a good idea to compare the terms they offer you with terms from their competitors, which might be more favorable. You can get a sense of what rates are out there by using a platform like Breezeful, which allows you to compare a number of different HELOC rates simultaneously before deciding which to apply for.

HELOCs can make home ownership more affordable for many Canadians, because they reduce or eliminate the amount of principal that must be paid down each month. That flexibility, however, is a double-edged sword, leaving some borrowers making interest-only payments indefinitely. According to the Financial Consumer Agency of Canada, about 40% of HELOC borrowers don’t make regular payments against their outstanding principal, and about one-quarter pay only the interest or minimum payment. Because of this, the agency has raised concerns that borrowers may increasingly be at risk of losing their homes if interest rates climb.

To make sure this doesn’t happen, borrowers must pass a stress test to get a HELOC from a bank; other lenders may also use the test to determine eligibility. What this means is that lenders check to make sure borrowers are financially secure enough to make their payments even in the event that interest rates increase by about 2%. The FCAC also suggests borrowers come up with a clear plan for how they will use and repay money borrowed against their home equity line of credit, and that they avoid borrowing money to cover monthly expenses for any prolonged period.

Best Line of Credit Rates in Canada

Canadian financial institutions typically do not offer specific, universal interest rates for their LOCs; instead they usually determine LOC interest rates on a case-by-case basis depending on an applicant’s income, existing debt, and credit score. The interest rate that the applicant receives is a combination of the financial institution’s prime rate, as well as an ‘adjustment factor’ based on their financial profile. This variable interest rate will then go up and down as the prime rate gradually changes.

Most Canadian banks have the same prime rate, currently 2.45%, but there might be other small differences in their LOC offers, and some even have promotions from time to time. If you have a strong credit score you can simply apply for an LOC with your usual bank, or you might be able to get a better rate at a competing bank.

If you’re a subprime borrower—i.e. you have a below-average credit score—you will probably be turned down for an LOC with a traditional bank. But you can still get a line of credit via alternative online lenders like Mogo or LendDirect. Keep in mind that a low credit score will correspond to LOC offers with high interest rates, which can really add up if you make only the minimum payment on your LOC. Before signing up for an LOC you should make sure that its lender won’t charge you a fee for early repayment; this caveat is even more critical for subprime borrowers, who will want to repay whatever money they withdraw from their LOC as quickly as possible.

 LOC Credit LimitCurrent Promotion/Special FeatureGeographical RestrictionsType of Lender
CIBC$5K+2.45% interest rate until March 6, 2022NoneTraditional
RBC$5K+Optional insurance in the event of borrower's disability, critical illness, or deathNoneTraditional
TD$5K–$50KFixed interest rate optionNoneTraditional
LendDirectUp to $50KLoan protection insurance availableAvailable in AB, BC, NB, NL, NT, NS, ON, PE, SKAlternative
Mogo$300–$3500No prepayment penaltyAvailable in BC, AB, MB, ON, PEI, NF, NB, NSAlternative

Line of Credit vs. Loan

There are a few key differences between a loan and a line of credit. A personal loan is a set amount of money you borrow to help pay for something specific, such as a car or a new dishwasher. Interest is calculated on the full loan amount and the debt is paid off in weekly or monthly installments. Once you’ve paid off the loan, you’re done. You can’t borrow any of the funds back again unless you apply for a new loan.

A line of credit, on the other hand, is a form of revolving credit, which means you can borrow, spend, and repay money on an almost endless cycle. Interest is calculated only on the money you borrow from your line of credit, and there is no set schedule to repay those funds.

In terms of cost, there are pros and cons to both forms of credit. The rate of interest you would pay on a line of credit is usually lower than what you would pay on a loan. But you could end up paying more in interest fees with a line of credit if you don’t pay back the money you’ve borrowed on a timely basis. Here’s a direct comparison of not only LOCs and personal loans, but also HELOCs and credit cards:

 Loan Amount/Credit LimitCredit TypeInterest TypeInterest RangeRepayment Terms
Personal Line of Credit$300–$50KRevolving; UnsecuredUsually variable; sometimes fixed4%+Minimum monthly payment; no grace period before interest is charged
Personal Loan$500–$50KLump sum; secured and unsecuredFixed3%–50%+Monthly repayment during term of 3 months to 5 years
Home Equity Line of CreditUp to 65% of a home’s market valueRevolving; securedVariable2%–10%10-year draw period followed by repayment
Credit Card$75–$50K+Revolving; secured and unsecuredFixed or variable7%–30%Minimum monthly payment; minimum 21-day grace period before interest is charged

Is a Line of Credit Right for Me?

To help you decide if a line of credit makes sense for you, here is a list of advantages and disadvantages to this form of borrowing.

Pros of an LOC

  • Usually have lower interest rates than personal loans or credit cards
  • You pay interest only on the amount you borrow, not the entire line of credit
  • Flexibility to pay back the money on your own schedule
  • No penalties for paying off your line of credit “early” or “late”
  • One-time application process
  • May save you money on bank fees, if your bank lets you transfer any overdraft on your regular account to your line of credit

Cons of an LOC

  • Interest rates are variable; if they rise you might have difficulty making your payments
  • You need to be disciplined to pay back the money you borrow since there is no set repayment timetable
  • You might be more tempted to overspend when you have credit easily available
  • Your bank or other lender can lower your credit limit or demand that you repay the loan at any time (with notice)
  • If you miss payments your credit score will suffer, making it more expensive for you to borrow in the future
  • With a secured line of credit, you could even lose your home or another secured asset if you miss payments

How to Get a Line of Credit

How to Get a Line of Credit

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If you’d like to open a line of credit, you can make an application online, over the phone or in person at a bank or other financial institution.

The lender will determine how much you can borrow (your credit limit) and what rate of interest you pay based on several factors:

  • Household income – most require at least $35K to $50K to qualify; except in the case of a student line of credit where a parent co-signs
  • Ability to repay – includes your income stability and how much other debt you currently carry
  • Credit history and credit score – the higher your score, the better the interest rate you’ll be offered
  • Home value – for a home equity line of credit only
  • Program of study/school – for a student line of credit only

Remember, you can shop around or negotiate with a lender if you’re not happy with the credit limit or interest rate initially offered to you. Also, don’t feel pressured to take the full credit limit; just like with a credit card you can ask for the limit to be lowered to an amount you are confident you can pay back.

Finally, be sure to ask about any administrative fees (or legal, title search, or home appraisal fees for HELOCs) the lender charges, and how much notice they will give you before making interest rate changes.

FAQs

A line of credit (or LOC) is a revolving credit product issued by financial institutions. Accountholders can utilize funds from the LOC up to its maximum credit limit, and the LOC’s available credit is refreshed as the accountholder repays what they’ve used.
Funds from a loan are typically provided to a borrower in a lump sum. If the borrower then wishes to borrow money again, they must apply for a new loan. Those that have a line of credit can draw funds, repay, and draw funds again repeatedly up to the line of credit’s maximum credit limit.
Both a line of credit and a credit card are forms of revolving credit, but they are different products. Unlike most credit cards, used credit from an LOC is subject to a variable interest rate, and there is no grace period before interest begins to accumulate on funds drawn. Furthermore, LOCs typically do not generate cash back or rewards points like many credit cards do.
The period in which an accountholder can use funds from a line of credit, its draw period, will typically last around 10 years or so. This is followed by a phase in which the accountholder must repay any outstanding principal drawn, as well as interest on that principal.

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Author Bio

Tamar Satov
Tamar Satov is an award-winning journalist specializing in personal finance and parenting. Her work has appeared in Canadian Living, The Globe and Mail, Today’s Parent, Parents Canada, Walmart Live Better and many other consumer magazines and websites. She is the former Managing Editor of CPA Magazine, for Canada’s Chartered Professional Accountants, and contributes to other publications for finance professionals including FORUM, for Canada’s financial advisors. Tamar is also a big proponent of financial literacy and had a long-running popular blog on the topic, sharing advice and anecdotes on her efforts to raise a money-smart kid. She lives debt-free in Toronto, with her husband and son.

Article comments

15 comments
Kevin Gordon Thomas says:

Amazing article!! I went from no knowledge to a full grasp of different types of lines of credit- HELOC’s – and loans.

Thank you for your time to write this!

Daniel at GreedyRates says:

Hi Kevin,
Glad you found it helpful. That’s what we’re here for!

Help Seeker says:

Is opening up multiple lines of credits through differen banks within a short time span (about 2 weeks) a bad thing? I understand it will be a hard hit to credit score, but are there are consequences or cons to this?

Aaron Broverman says:

Hi Help Seeker.

Yeah, there are pros and cons (mostly cons) Basically yes, you will receive many hard inquiries on your credit score which will drive your score down and make it harder to borrow in the future. It also makes you look desperate and like a risky bet for lenders who will be less likely to lend to you or approve your applications. However, if you are approved, your credit utilization (because you will have lots of credit after approval) will override the hard inquiries to your credit score and your score will likely balance out eventually. However, that’s only if you can make your payments on time and keep track of multiple due dates. Also, the effect of hard inquires fade after a year and they stay on your report for two years. Also, getting an application declined doesn’t negatively affect your score. If you think you can juggle all those lines of credit go for it, but i wouldn’t recommend it as most people can’t and don’t have strong enough credit to where the inquires won’t have a major temporary impact.

RayzeR says:

Do you have any advice on leveraging a better rate from the Bank / institution? I currently have an unsecured open LoC through BMO. The rate is currently 2.45% +4, so 6.45%. I find this rate to be high, considering the current economic state during the pandemic, and have not realized any decrease in rate even though the ‘adjustment factor’ (+4%) is supposedly a ‘variable rate’. I’m greedily looking into rate offers from other institutions to bring back to BMO to leverage my position, however I cannot seem to get these rates easily as they’re dependent on credit score/risk?

Any advice?

Aaron Broverman says:

Hi Rayze,
The things that can put you in the best position to negotiate a better rate is being a long time customer and having a strong history of paying on time every month and never missing a payment. Once you have that, you can give your credit card company a call and ask. Don’t take no for an answer and always ask to speak to a supervisor. Bring up your history and your loyalty. You’ll be surprised what you might get just by asking. Before all this though, you should do your research because you might actually want to make the switch to a credit card issuer with a lower interest rate, but you have to know which ones those are. You also might want to do a balance transfer and pay off your credit card as quickly as possible at a lower balance transfer promotional rate without making any new purchases. I hope that helps.

Nor says:

H!
I have a question, I have a full time, permanent job in the financial/IT domain with very good credit history. I’m planning to open an unsecured line of credit. Wondering what “standard” documents should be prepared, other than T4, paystubs, employment letter? Noting that am considering to apply for the LOC with the same bank I have most of my accounts (salary, saving…etc.)

I am concerned as I’ve heard that some financial institutions ask for extra unnecessary information/documents such as 90 days statement of RRSP and any investments accounts. Does this sound a right request?

Thank you,

Hafiz says:

Hello,
I have a question, I have a full time, permanent job and making around 40k yearly, I have only student loan with NSLSC which is only $2260.
I am planning to open an unsecured line of credit to access $10000 and doing my home work to get the best possible rate. My question is, is that possible that once I get approved and use $10000 from my line of credit and then immediately transfer to MBNA’s True Line credit card to save myself from paying interest on my line of credit for next 10 months? I am just wondering if such scenario is possible?
Thanks!

Aaron Broverman says:

Hi Haifiz,
There are some limitations. You can only transfer a balance from a line of credit to the True Line MBNA Credit card once you are approved for the credit card, so you would need to wait to be approved for the line of credit, put the balance there and then subsequently be approved for a limit of $10,000 on the MBNA True Line Card right after you get approved for the same limit on your line of credit. Such a thing may still be possible, but the approval may take longer than you’re anticipating. It also will likely briefly hurt your credit score by having so many credit inquiries into your file in a short period of time, as well as maxing out your credit limit so immediately. Anything is possible of course. I don’t know enough about your credit situation to know if you’ll get approved.

Help seeker says:

If I borrow a 1000$ from my LOC and repay it back in a week, or even a day, I will still have to pay the interest on it, correct? I just don’t understand how much the interest part will be if I borrow multiple times before repaying the whole amount. Also, if my credit cards debt is large, would consolidating them in LOC be the best approach? given the discipline to repay and not using the credit cards anymore.

Nate Siegel says:

Hi Help Seeker,

Thanks for coming to GreedyRates. If you decide to use $1,000 from your LoC, then you will definitely need to pay interest on it. Interest on most lines of credit is calculated using the average daily balance method, which means compounding daily, so paying it off the next day will still mean a slightly higher balance than the amount you used. Just divide your APR by 365 and multiply that by the $1,000 to see a rough estimate. If you also have other sources of debt like a credit card, we can provide some suggestions for consolidation that go beyond another line of credit.

If you’re able to consolidate at a lower rate, that’s always what’s best. The cream of the crop in this regard is MBNA’s True Line credit card, which has a balance transfer option that can be used with other cards’ balances and lines of credit as well. When you transfer you’ll pay 0% interest on that balance for 10 months, and then 12.99% after the promotion ends, with no caveats other than a 3% transfer fee and monthly minimum payments. This will probably be a better option than a line of credit. Best of luck!

GreedyRates

Pamela says:

For personal lines of credit, which financial institutions give the lower interest rates, credit unions or banks?

The GreedyRates Team says:

Hey Pamela,

Great question. Here’s how it goes, banks are for-profit and credit unions are not-for-profit universally, so the former has an incentive to charge lower rates in order to get more clients and make more money. Because credit unions are essentially financial cooperatives, they need to be able to sustain themselves and therefore charge higher rates usually. However, your credit profile will have the largest impact on which loan or line of credit suits you best, and so it’s worth doing due diligence and checking on both sides of the industry.

One idea to understand however is that your own bank—the one most familiar with you—will also be more comfortable with the idea of you borrowing from them. We’ve seen that one’s existing bank tends to offer them better terms on average, so start there and then begin exploring other local options. Best of luck!

GreedyRates

Linda says:

My line of credit will be paid off in a few days. What will happen when a cheque is cashed on the available amount that was written before the line of credit was paid?

The GreedyRates Team says:

Hey Linda,

Interesting comment, much appreciated. If you have an open line of credit, and the balance on the line of credit is $0 (meaning there’s nothing to repay), then your cheque will cash and increase your balance by that much. This is assuming that by “paid off” you don’t mean “closed”. If you’ve closed your line of credit and have also written someone a cheque that draws from it, the cheque will bounce.

Just because your previous line of credit balance was paid, that doesn’t mean there’s $0 available. You’ve just utilized $0 of it, meaning you pay no interest or fees. Once the cheque cashes then your balance will begin collecting interest, at which point you do need to start figuring out how to pay it off. Hope we understood your comment correctly, and if not just let us know! If you’d like to provide more detail but are afraid of posting personal info, you can email us at [email protected]. Thanks!

GreedyRates