A Line of Credit (LOC) is an agreement between a borrower and the lender (bank or an NBFC) which states that the lender is ready to lend a certain maximum amount to the borrower. The borrower can withdraw money any time he or she wants until they reach the maximum limit. The interest is charged only on the borrowed amount, not on the maximum amount (total amount sanctioned). This is one of the biggest advantages of a line of credit. The money borrowed can be used for any purpose and to fulfil any type of requirement.
In case of a financial crisis, businesses desire to avail some easy liquidity to deal with the situation. To address this need of businesses and organisations, banks and other financial institutions provide lines of credit to meet the immediate needs of companies that are in need of working capital. These loans are extremely beneficial to companies as they can avail financial support whenever they require working capital.
Understanding Line of Credit
The Line of Credit can prove to be very helpful for those in need of financial aid at regular intervals. The borrower can apply for the required loan amount from a bank but he or she needn’t take the entire amount in one go.
Once the loan amount is approved, the borrower can take a small amount out of the entire fund to meet current needs and keep the remaining amount with the bank. The interest will be charged only on the amount that the borrower has withdrawn and not on the entire amount. As a result, the customer can manage his or her monthly expenses easily without getting burdened with the loan EMIs.
In a Line of Credit, the borrower also has to pay a lower interest rate compared to a traditional loan. It is like a credit card where you can pay the charges only for the amount that you have used and not for the entire credit limit.
How to get a Line of Credit?
There are several banks offering lines of credit loans for both personal and business purposes. When it comes to applying for a line of credit loan, it is an easy and simple process. It depends on the type of loan you want and whether a line of credit is available for the same. The process is more or less similar to applying for a loan.
Compare lenders and choose your preferred lender.
Approach the lender and submit your application form.
The lender checks your creditworthiness - i.e. evaluates whether you’re eligible for a line of credit. The actual eligibility criteria varies from one lender to another. Some factors the lender considers are - credit score of the borrower, years in business, income levels, profit/loss statements of the business, etc.
Based on your creditworthiness, the lender decides if you’re eligible for the line of credit. Additionally, the lender decides the - maximum amount, interest rate and tenure of the line of credit.
Once you approve the terms of the line of credit, the amount is credited in a separate bank account, from which you can withdraw any time.
Differences Between a Loan and a Line of Credit
There is a thin line of difference between traditional loans and a line of credit. Both are credit instruments, through which the borrower can get access to a particular amount of money. The amount borrowed depends on the borrower’s eligibility and credibility. In both cases, the borrower is bound to repay the borrowed amount through monthly instalments (EMIs) or quarterly instalments.
|Traditional Loans||A Line of Credit|
|Borrow a lump sum in one go.||
The borrower is provided with a maximum amount.
|If you require additional amounts, you have to go for a new loan.||
The borrower can withdraw any number of times, until the maximum limit is exhausted.
|Interest is charged on the entire amount borrowed.||
Interest is charged only on the amount withdrawn.
Types of Line of Credit
There are two main categories of Line of Credit (LOC), which are as below:
Secured - In Secured LOC, the interest rate charged by the bank is relatively low. This is because, in a secured line of credit, banks offer loans after accepting some of your valuable assets as security. Moreover, the income of the borrower will also be considered along with his or her credit score before finalising the rate of interest.
Unsecured - The interest charged by the banks in this type of LOC is higher compared to the interest rate of secured LOC. The banks do not take any of the borrower’s assets as security under an unsecured LOC. Therefore, the chances of repayment are slightly on the lower side in this type of credit and consequently, the rate of interest goes high.
Benefits of Lines of Credit
Here are some of the key benefits offered by Lines of Credit:
Borrowers can take a limited amount in the line of credit system, whereas in the typical lending process the borrower cannot avail an amount lower than the minimum amount set by the concerned bank.
The rate of interest charged by banks on LOC is relatively lower than the traditional loans.
The interest rate has to be paid only for the used amount of the entire credit limit. For the rest of the amount, no interest rate will apply to the borrower.
For self-employed individuals, LOC is immensely beneficial as they can take the amount in a smaller quantity and start a business with low risk.
This provides mental peace to the people who are into business as they know they have a substantial amount of money in the bank that can be claimed any time if required.
Individuals who don’t want to go for personal loans owing to the high-interest rates charges, can easily opt for LOC and meet their needs.
In LOC, you can expect to have a very high credit limit compared to the limited loan amount offered in traditional loans.
Line of Credit comes with many benefits for self-employed individuals or even business professionals with unstable monthly income. It can act as a saviour for individuals who are in constant need of money at any time during the year. It allows the borrower to withdraw the amount that he or she needs to meet the existing need. Also, the interest is charged only for the amount that one uses regardless of how much amount is sanctioned. An increasing number of borrowers are starting to prefer a Line of Credit, over other loan types.