What a line of credit is and how it works
A line of credit is a revolving borrowing account. The lender approves you for a maximum limit, you draw what you need, and every dollar you repay becomes available to borrow again while the account stays open and in good standing. You pay interest on the amount you actually owe, not on the limit. That revolving structure is the main difference from an installment loan, which pays out a single lump sum and does not refill as you pay it down.
So what is a line of credit in practice? It is three numbers in one contract: a limit, a rate, and a minimum payment rule. The limit is the ceiling on how much you can draw at once. The rate is often expressed as a margin above or below a lender's prime rate, and that margin is set by the lender based on your file, not by any published benchmark. The minimum payment rule is what determines whether the balance falls over time or simply sits there.
The question of how does a line of credit work therefore comes down to reading those three terms together, because they interact. A generous limit with an interest-only minimum and a rate at the higher end of your lender's range behaves very differently from the same limit on a schedule that retires principal.
The Financial Consumer Agency of Canada's guide to personal loans sets out how personal loan and line of credit agreements work and what your lender has to disclose to you before you sign.
Unsecured and secured lines of credit
Two broad types dominate the Canadian market. An unsecured personal line of credit is not tied to any asset, so the lender is relying on your income and your credit history. A secured line of credit, most commonly a home equity line of credit, is registered against property, which generally supports a larger limit because the lender holds collateral. At federally regulated lenders, a home equity line of credit is generally limited to 65% of appraised property value, with total secured lending usually capped at 80%.
In day-to-day use, a line of credit behaves like a flexible account you access by transfer, cheque or card. Interest normally accrues on the outstanding balance from the day it is drawn, and the lender issues a statement showing the balance, the interest charged for the period, and the minimum payment due. Because the account is open-ended, there is no scheduled final payment unless your agreement creates one.
Revolving limits, interest-only minimums, and why a balance can sit unchanged for years
This is the part of a line of credit that surprises people most. With an installment loan, the payment schedule is built to retire the debt by a set date. With a revolving line, the payment rule is often set to keep the account current rather than to retire the debt.
Three mechanics explain a stubborn balance:
- Interest-only minimums. Some agreements require only the interest accrued in the period to be paid. If your minimum equals the interest, the principal does not move at all. You can make every payment on time for years and owe exactly what you owed at the start.
- Slow principal reduction. Other agreements require a small percentage of the outstanding balance. That does reduce principal, but at a small percentage it happens slowly, and the interest portion shrinks only gradually. A payment that feels like progress can be mostly interest.
- Offsetting draws. Because the limit refills, new spending works against your repayments. If you deposit a paycheque into the line and then draw it back out, you are not reducing the balance, you are recycling it.
The rate compounds the effect. On a higher-rate facility, more of each payment goes to interest and less to principal, so the same payment retires debt more slowly and the account takes longer to move.
Comparing the options
The table below contrasts the main ways to borrow against a limit or a lump sum. It describes structure, not offers. No row is a quote, and no figure is attached to any product.
| Option | Revolving? | Security | How the payment is set | Where the rules come from |
|---|---|---|---|---|
| Unsecured personal line of credit | Yes, the limit refills as you repay | None | The agreement sets a minimum, often interest plus a small share of principal | Lending is licensed provincially; consumer complaints about federally regulated institutions go to the Financial Consumer Agency of Canada |
| Home equity line of credit | Yes | Registered against property | Often interest-only during an initial period, with principal repayment required later; the agreement controls | At federally regulated lenders, generally limited to 65% of appraised property value, with total secured lending usually capped at 80% |
| Installment personal loan | No, a fixed lump sum | Usually none | A fixed schedule designed to retire the debt by a set date | Lending is licensed provincially |
| Credit card | Yes | Usually none | A percentage-of-balance minimum set in the cardholder agreement | Lending is licensed provincially |
| Payday loan | No | None | A single repayment, generally up to $1,500 for a term of 62 days or less | Where a province operates a licensed payday lending regime, the federal Payday Lending Regulations cap the cost of borrowing at $14 per $100 advanced. Some provinces set a lower cap, and the lower cap applies. Quebec does not license payday lending, which effectively prohibits the model there. |
The Criminal Code criminal rate of interest is 35% per year (s. 347). That is the outer edge of the legal market, not a typical rate, and it is not a benchmark anyone should expect to pay.
What actually decides your limit, your rate and your minimum
Lenders price and approve by risk. The inputs are consistent across the market, even where the answers differ:
- Income and stability. Documented, predictable income supports a larger limit than income that varies widely.
- Credit history. Canada has two national credit reporting bureaus, Equifax Canada and TransUnion Canada. A lender may check one or both.
- Existing debt load. How much you already owe, and how much of your income goes to servicing it.
- Whether the facility is secured. Collateral generally supports a larger limit at a given income level.
- Lender policy. Lending in Canada is licensed provincially, so the regulator and the rules differ depending on where you borrow.
Where a home equity line of credit is wrapped into a mortgage application, federally regulated mortgage lenders generally work to a total debt service ratio ceiling of about 44%, and qualify an uninsured mortgage at the greater of the contract rate plus 2 percentage points and 5.25%, under OSFI Guideline B-20. A line of credit that increases your monthly obligations therefore affects what you can borrow on the mortgage side.
Interest, benchmarks and what a line of credit costs
The Bank of Canada publishes the policy interest rate, the prime rate, conventional mortgage rates and Government of Canada benchmark bond yields. These are benchmarks, not offers, and no lender is obliged to lend at them. A line of credit rate is a commercial decision your lender makes about your file. The lowest rates are only available to the most qualified applicants.
One contrast is worth knowing: Canadian fixed-rate mortgages are compounded semi-annually by law. Lines of credit are not mortgages, and how their interest is calculated is set by your agreement, so read the disclosure your lender provides rather than assuming the mortgage rule carries over.
The Financial Consumer Agency of Canada is the federal starting point for what a lender must tell you about the cost and terms of a personal line of credit.
What a revolving balance does to your credit file
A line of credit is reported as an account, and lenders report how you use it. Two things tend to matter: whether you pay on time, and how close your balance sits to the limit. A facility that is fully drawn for a long stretch reads differently from one that is lightly used, even if both are paid on time.
Serious credit events have defined timelines. A consumer proposal stays on a credit report for 3 years after completion, or 6 years from filing, whichever comes first. A first bankruptcy stays on a credit report for 6 years after discharge. Only a licensed insolvency trustee can administer a consumer proposal or bankruptcy.
How to stop a revolving balance from standing still
- Pay more than the interest portion every period, and check the agreement to see what the minimum actually covers.
- Separate everyday spending from the facility where you can, so new draws stop offsetting repayments.
- Ask your lender directly what your minimum payment is composed of. Interest-only and percentage-of-balance minimums behave very differently.
- Compare the line against the cost of a fixed installment loan for a balance you already know you will not repay quickly. Converting a revolving balance into a scheduled one is the standard way to force principal down.
- Read the disclosure before you draw, not after.
Everything above is general information about how these products work, not advice for your situation. Whether a line of credit, an installment loan or something else fits depends on your income, your other debts and your plans, so the answer genuinely varies from person to person. For decisions with significant consequences, talk to a regulated professional.
loanmoose.ca is not a lender. It does not make loans, set rates or make credit decisions. It is a Canadian loan matching and comparison service that connects people with lenders and product options.