How Does Interest Work on a Line of Credit?

A line of credit is a type of loan that allows you to borrow money as needed, up to a certain limit. The interest on a line of credit is calculated differently than on a traditional loan.

With a line of credit, you are only charged interest on the amount you borrow, not on the entire credit limit. For example, if you have a line of credit with a $10,000 limit but only borrow $5,000, you will only pay interest on the $5,000 that you have borrowed.

The interest rate on a line of credit is typically variable, which means it can go up or down based on market conditions. The rate is usually tied to the prime rate, which is the interest rate that banks charge their most creditworthy customers.

Interest is typically charged monthly on a line of credit, and the amount of interest you pay is based on the outstanding balance of the credit line. So, the higher your balance, the more interest you will pay.

It’s important to note that some lines of credit may have a minimum monthly payment that includes both principal and interest. In this case, even if you don’t borrow the full amount of your credit limit, you may still be required to make a minimum monthly payment that includes interest on the full credit limit.

Overall, a line of credit can be a flexible and convenient way to borrow money, but it’s important to understand how interest works and to make sure you can make the required payments on time to avoid high interest charges and potential penalties.