Does a Line of Credit Affect My Credit Score: What You Need to Know

A line of credit is a flexible financial tool from a financial institution providing access to funds when needed, offering more control over borrowing than traditional loans. While it can be a convenient way to manage unexpected expenses or finance large purchases, it’s essential to understand how a line of credit impacts your credit score.

From credit utilization to payment history, how you handle a line of credit can positively or negatively affect your financial health. This guide will explore how a line of credit affects your credit score, what factors to watch for, and how to use it responsibly to maintain or improve your credit standing.

What is a Line of Credit?

A personal line of credit is a flexible loan that allows you to borrow up to a set limit rather than receiving a lump sum. You can withdraw funds, repay them, and borrow again, only paying interest on the amount you use. It's commonly used for:

• Emergency Expenses: Cover unexpected costs like medical bills or car or home repairs.

• Cash Flow Management: Help manage short-term cash flow gaps, such as during fluctuating income periods.

• Large Purchases: Finance big-ticket items like appliances, furniture, or vacations.

• Debt Consolidation: Pay off higher-interest debts, like credit card balances, to reduce overall interest costs.

• Business Expenses: Provide working capital for small business owners to cover operational costs or inventory.

• Home Improvements: Fund home renovations or repairs without needing a home equity loan.

• Building Credit: Use it responsibly to improve your credit score by maintaining low utilization and making on-time payments.

• Convenient Borrowing: Access funds quickly and easily without needing to apply for a new loan each time.

Benefits of a Line of Credit

A personal line of credit offers several benefits, including flexibility in borrowing, as you can access funds when needed without reapplying. You only pay interest on the amount you use, and it can help manage cash flow, handle emergencies, or finance larger expenses. Additionally, responsible use can improve your credit score over time.

What's a Credit Score?

A credit score is a numerical representation of your creditworthiness, typically ranging from 300 to 900 in Canada. It helps lenders assess how likely you are to repay borrowed money. The higher your score, the better your chances of being approved for credit with favourable terms.

Several factors affect your credit score:

1. Payment History: On-time payments boost your score, while late or missed payments lower it.

2. Credit Utilization: The percentage of your available credit you're using. Keeping your credit utilization below 30% positively impacts your score.

3. Credit History Length: The longer your accounts have been open and in good standing, the better your score will be.

4. Types of Credit: A mix of credit types, such as credit cards, loans, and mortgages, can improve your score.

5. Credit Inquiries: Frequent hard inquiries from applying for new credit can slightly lower your score.

Credit History and Line of Credit Approval

A strong credit history, characterized by on-time payments, low credit utilization, and diverse credit accounts, signals to lenders that you are financially responsible. This can lead to higher chances of approval and more favourable terms, such as a larger credit limit and lower interest rates. Lenders may offer additional perks to those with good credit, like reduced fees or flexible repayment options.

Conversely, if your credit history shows missed payments, high levels of debt, or frequent credit inquiries, lenders may view you as a higher risk. This could result in your application being denied or approved with stricter terms, such as a lower credit limit and higher interest rates.

You may be required to secure the line of credit with collateral, especially if your credit score is lower than the lender’s minimum threshold. Therefore, maintaining a solid credit history is essential for accessing a line of credit on favourable terms.

Does a Line of Credit Affect Your Credit Score?

A line of credit can positively or negatively impact your credit score, depending on how you manage it.

Credit Utilization

Credit utilization refers to the amount of credit you use compared to your total available credit. For example, if you have a $10,000 line of credit and used $3,000, your utilization rate is 30%. This is a critical factor because credit scoring models, like FICO and VantageScore, consider a lower utilization rate (ideally below 30%) as a sign of responsible credit management. High utilization, especially above 50%, can negatively impact your credit score because it may indicate that you're overly reliant on credit.

A line of credit offers flexibility, and keeping your usage low relative to your available credit can help maintain or improve your credit score. On the other hand, maxing out your line of credit could harm your score, even if you’re making payments on time.

Payment History

Your payment history is the most important factor affecting your credit score, often accounting for about 35% of your score in many credit scoring models. Timely payments on your line of credit can boost your credit score over time, as they demonstrate your ability to manage debt responsibly. Each on-time payment reflects positively on your payment history, signalling to lenders that you're reliable.

However, missed or late payments on a line of credit can significantly damage your score. Even one missed payment could cause a noticeable drop, especially if you’re typically diligent about paying on time. Consistently late payments can drop your credit score, and if the account defaults, it could have even more severe long-term consequences.

Credit Inquiries

When you apply for a line of credit, the lender will perform a hard inquiry on your credit report. This type of inquiry can cause a small, temporary dip in your credit score, usually by a few points. While one hard inquiry doesn’t have a major impact, multiple inquiries in a short period—such as applying for several lines of credit or loans—can raise red flags for lenders. They might see this as a sign of financial instability, which could lead to a more significant reduction in your credit score.

Soft inquiries, on the other hand, such as when you check your credit or when lenders pre-approve you for offers, do not affect your credit score.

Length of Credit History

The length of your credit history is another factor influencing your score, typically accounting for around 15% of the total score. This considers how long each credit account has been open and the average age of all your accounts. Keeping a line of credit open for a long time, especially if you’re managing it well, can benefit your credit score.

Even if you’re not actively using the line of credit, simply having it open can improve your credit score by contributing to the age of your credit accounts and increasing your overall available credit, which helps with credit utilization.

However, closing a line of credit can have the opposite effect. When you close an account, you reduce your total available credit, which can increase your credit utilization ratio if you still have balances on other accounts. Additionally, closing a long-standing account reduces the average age of your accounts, which can negatively affect your score.

Types of Credit

A mix of credit types, such as revolving credit and instalment credit like personal loans, can positively impact your credit score. Lenders and credit scoring models like to see that you can manage different types of credit responsibly.

A line of credit is considered revolving debt, similar to a credit card. You can borrow money and repay repeatedly as long as you stay within your limit. Successfully managing revolving credit and instalment loans can help diversify your credit profile, which may improve your credit score over time.

Account Age and Stability

Maintaining a line of credit for an extended period can contribute to a stable credit history. Lenders prefer seeing long-standing accounts with positive payment histories. If you close a line of credit, especially an older account, it can shorten your average account age and potentially lower your score. Even if you’re not using the line of credit, keeping it open and in good standing can benefit your overall credit health.

Managing Your Line of Credit Responsibly

Managing your line of credit responsibly is key to maintaining a healthy financial profile and positively impacting your credit score.

Keep Credit Utilization Low

Aim to keep your credit utilization below 30% of your available limit. This helps maintain a healthy credit score and shows lenders you’re not overly reliant on borrowed funds.

Make Payments on Time

Always make at least the minimum payments on or before the due date. Late payments can significantly hurt your credit score and result in penalties or higher interest rates. Set up automatic payments or reminders to ensure you never miss a due date.

Pay More Than the Minimum

Paying more than the minimum when possible can help you reduce interest costs and pay off the balance faster. The longer you carry a balance, the more interest you’ll accumulate, so aim to pay off as much as you can afford each month.

Avoid Maxing Out Your Credit

Even if you have a high credit limit, avoid maxing it out. High utilization can make lenders view you as a credit risk and negatively impact your credit score. Always leave a buffer between your balance and your credit limit to maintain a healthy ratio.

Monitor Your Spending

It’s easy to overspend when you have access to credit. Create a budget to manage your spending and ensure you only borrow what you can comfortably repay. Monitoring your transactions can help prevent unexpected debt accumulation.

Review Your Statement Regularly

Check your line of credit statements every month for accuracy. Reviewing your transactions helps you catch any errors or unauthorized charges early, allowing you to address them before they become bigger issues.

Keep Your Account Open

Even if you don’t need to use your line of credit regularly, keeping it open can benefit your credit score. It increases your total available credit, which helps with your overall credit utilization ratio. Additionally, maintaining long-standing accounts reflects positively on your credit history.

Limit New Credit Applications

Each time you apply for new credit, a hard inquiry is made, which can temporarily lower your credit score. Limit how often you apply for new lines of credit, and only do so when necessary to avoid negatively affecting your credit score.

Use Credit for Planned Purchases

It’s best to use your line of credit for planned expenses or emergencies rather than impulse spending. This helps you control your finances and reduces the risk of financial trouble.

Seek Help if You're Struggling

If you're finding it difficult to keep up with payments, contact your lender early to discuss options such as a lower interest rate or a revised payment plan. Ignoring financial difficulties can lead to missed payments and negatively impact your credit score.

Apply for a KOHO Line of Credit

The KOHO Line of Credit offers a range of benefits for those focused on improving their financial health. It supports credit-building with responsible use, while the High-Interest Savings Account (HISA) helps grow your savings alongside credit management.

With a virtual credit card for secure transactions, free credit score monitoring, and overdraft protection, KOHO provides comprehensive tools for financial control. For business owners, KOHO offers flexible, tailored solutions to streamline business finances, making it a versatile solution for diverse needs.