A line of credit is a flexible borrowing account that lets you draw money up to a set limit, repay it, and borrow again while interest is charged on the outstanding balance. In Canada, it differs from an instalment loan because the credit revolves rather than being paid out once.
A line of credit is a revolving borrowing account. The lender approves a limit, and you can draw money as needed, repay it, and draw again. Interest is charged only on the amount you actually owe, usually calculated daily and billed monthly. That flexibility is the main difference from a personal loan, which pays out a single sum and is repaid on a fixed schedule.
| Feature | Line of credit | Instalment loan |
|---|---|---|
| Advance | Draw as needed up to a limit | One lump sum at approval |
| Repayment | Flexible payments, often with a minimum | Fixed payment schedule |
| Interest | Charged on the outstanding balance, often variable | Fixed or variable, set at approval |
| Term | Open-ended, subject to lender review | Set term chosen at approval |
| Typical use | Cash-flow gaps, emergencies, variable costs | Major one-time purchases, debt consolidation |
Because the balance can go up and down, a line of credit behaves more like a credit card than a loan, but it often has a lower interest rate and a higher limit. The exact terms depend on the lender, the borrower's credit profile, and whether the credit is secured.
How a line of credit works
When you apply, the lender reviews income, credit history, debts, and assets. If approved, you receive a credit limit. You can then transfer money from the line of credit to your chequing account, write a cheque, use a linked card, or pay a bill directly, depending on the product. Each withdrawal increases the balance; each payment reduces it. As long as the account is in good standing and within the limit, you can borrow again.
There are two broad types: unsecured and secured. An unsecured line of credit is based on your creditworthiness and usually has a lower limit and a higher interest rate. A secured line of credit is tied to an asset, often home equity, and may offer a larger limit and lower rate because the lender has collateral. A home equity line of credit (HELOC) is a common example. Secured credit can put your asset at risk if you default, so it is important to understand the consequences before using it.
Most lines of credit are demand facilities. That means the lender can require repayment or reduce the limit under the contract terms, although in practice this usually happens only if payments are missed or the lender's risk changes. The agreement will show whether the limit is reviewed, whether there is an annual fee, and what happens if you miss a payment.
How interest is charged
Interest on a line of credit is usually calculated on the daily outstanding balance and charged monthly. If you carry a balance, you pay interest; if you pay the balance in full before the due date, you may pay little or no interest for that period, depending on how the lender calculates it. The rate is often variable and tied to a benchmark such as the lender's prime rate. The Bank of Canada publishes policy interest rate data that influences short-term borrowing costs, but the rate you pay is set by your lender and can change when the benchmark changes. See the Bank of Canada interest-rate data for context.
Variable rates mean your payment can rise when rates rise. If you borrow $10,000 at a variable rate and the rate increases, more of your payment goes to interest, and the time to repay can stretch unless you increase payments. A fixed-rate instalment loan gives you a predictable payment, which can make budgeting easier.
There is a legal ceiling on criminal interest rates in Canada. Under the Criminal Code, the criminal interest rate is 35% per annum, subject to regulations. That ceiling does not mean every rate below 35% is affordable or suitable; it is a legal limit, not a recommendation.
Line of credit vs instalment loan
An instalment loan is a closed-end credit product. You borrow a set amount, receive it once, and repay it over a set term with scheduled payments. The interest rate may be fixed or variable, but the structure is predictable. A line of credit is open-end credit: the account stays open, and you control how much you draw and when you repay. The Financial Consumer Agency of Canada's loans information explains that different loan products have different costs and obligations, so comparing the total cost, not just the advertised rate, matters.
An instalment loan is often used when a borrower needs a one-time sum and wants a clear finish date. A line of credit is often used when a borrower needs flexible access to cash for variable or recurring expenses, such as renovations, tuition timing gaps, or seasonal business costs. A line of credit can be cheaper if the balance is repaid quickly, but it can be more expensive if the balance sits for years with only minimum payments.
Line of credit vs credit card vs overdraft
A credit card is also revolving credit, but it usually has a higher interest rate, a smaller limit, and different consumer protections. A line of credit often has a lower rate and is better suited to larger or longer-term balances. Overdraft protection is another form of revolving credit tied to your chequing account; it covers short-term shortfalls and may have daily fees or interest. Each product has a place, but they are not interchangeable.
If you are comparing costs, look at the annual percentage rate, any annual fee, transaction fees, and how interest is calculated. The FCAC's credit reports and scores guide notes that credit history affects the rates and limits you are offered, so checking your report before applying can help you spot errors.
What lenders look at and how co-signers fit
Lenders assess income stability, debt-to-income ratios, credit score, payment history, and collateral. A co-signer can strengthen an application by adding income and credit history, but co-signing is not a favour without risk. The co-signer is legally responsible if the primary borrower defaults, and the debt appears on the co-signer's credit report. For more on this, see what a co-signer is.
If you have damaged credit, a secured line of credit or a co-signed loan may be possible, but the cost and risk are usually higher. See bad-credit loan options for the trade-offs. A loan payment calculator can estimate payments and total interest under different scenarios before you borrow.
Common mistakes with lines of credit
- Treating the limit as income. A line of credit is debt, not extra cash flow.
- Making only minimum payments. This can keep the balance alive for years and increase total interest.
- Ignoring rate changes. Variable rates can rise, increasing the cost of the same balance.
- Using a line of credit for long-term debt without a repayment plan. A fixed loan may be more predictable.
- Co-signing without understanding default consequences. The co-signer can be pursued for the full balance.
- Missing payments. Default can lower your credit score, trigger collection activity, and in secured cases put your asset at risk.
In short, a line of credit is a flexible tool for managing cash flow, but it requires discipline. Understand the limit, the interest calculation, the repayment terms, and what happens if your circumstances change. If you are considering a co-signer or comparing loan types, review the agreement carefully and consider how the debt fits your budget before you sign.