How Does Interest Work on a Line of Credit?

With a line of credit, you only pay interest on the money you actually borrow. You do not pay interest on your entire credit limit.

Interest usually starts from the day you withdraw money. It continues until you repay the balance.

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How Is Line of Credit Interest Calculated?

Most lines of credit calculate interest using your daily outstanding balance.

A simple estimate is:

Interest = Balance × Annual Interest Rate × Days Borrowed ÷ 365

For example, suppose you borrow $5,000 from a line of credit with a 10% annual interest rate. You keep that balance for 30 days.

You would pay approximately $41.10 in interest for those 30 days.

Your actual interest can vary as your balance changes throughout the month.

Do You Pay Interest on the Full Credit Limit?

No.

Suppose your line of credit has a $20,000 limit. You only borrow $3,000.

You pay interest on the $3,000 balance. You do not pay interest on the remaining $17,000 of unused credit.

When Does Interest Start on a Line of Credit?

Interest generally starts as soon as you borrow the money.

Lines of credit usually do not have the same interest-free grace period that many credit cards offer for purchases. Interest continues to accumulate until you repay the amount you borrowed.

Are Line of Credit Interest Rates Fixed?

Most lines of credit have a variable interest rate.

The rate is often based on the lender's prime rate plus an additional percentage.

For example, your rate might be:

Prime + 2%

If the lender's prime rate changes, your line of credit rate can also change. Your borrowing costs can therefore increase or decrease over time.

How Do Line of Credit Payments Work?

Your lender will give you a minimum payment each month.

Some lines of credit allow minimum payments that mainly cover the interest you owe. This can keep your account in good standing. It does very little to reduce the amount you originally borrowed.

Paying more than the minimum can help you reduce the principal faster. It can also reduce how much interest you pay overall.

How Can You Pay Less Interest on a Line of Credit?

The simplest way is to reduce your outstanding balance as quickly as you can.

You can also:

• Borrow only what you need

• Make more than the minimum payment

• Make additional payments when possible

• Avoid repeatedly borrowing after paying the balance down

• Keep an eye on changes to your variable interest rate

Interest is based on how much you owe and how long you owe it. A smaller balance held for less time usually means less interest.