A line of credit allows a business to borrow funds as needed. The bank allows the borrower withdraw money up to a maximum credit line at varying interest rates. For example interest rate might be 5% one month and 6% the next.
Unlike a loan or a note, the line of credit is not paid in equal installments. A line of credit works like a credit card, the borrower is issued a credit line and the borrower can access the funds as needed. No interest is accessed unless the user borrows the funds. In months when cash flow is good, the borrower can pay the full amount owed and in slower months, the borrower can choose to pay less.
Line of credits are short term in nature and can be extended indefinitely by renewing the terms.
Find below a table summarizing how a line of credit works:
Uncle Joe borrows the following amount as shown below:
- In March he borrows $10,000 at 8%
- In April he paid back the $10,000 and borrowed $25,000 at 8.5%
- In May he paid back $20,000 and borrowed $5,000 at 7.5%
- In June he paid off his balance of $10,000
|Period||Amount borrowed or (Repaid)||Loan balance at end of month||Effective interest rate per month||Interest Expense|
End of Lesson 10