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Introduction

Financial emergencies always create an urgent need for access to quick money. Loans are very helpful for people looking for immediate financial support in certain circumstances. to help individuals deal with such emergency cash needs, banks and NBFCs offer a variety of loan products for meeting emergency financial needs.

The traditional lending mechanism has its limitations since most banks have a minimum threshold below which a loan is not offered. Sometimes, borrowers may not require larger amounts but are forced to borrow a large sum because of the bank’s norms. As a consequence, borrowers end up paying high EMIs every month.

Even if they use only a portion of the total loan amount, the bank charges interest on the total amount borrowed. This results in additional interest outgo which could create a cash crunch for the borrower. This is where a Line of Credit comes into the picture.

What is a line of credit?

Line of Credit is ideal for those in need of financial assistance at frequent intervals. Under this, the borrower can apply for a specific loan amount but it is not necessary to borrow the entire amount in one go. After the loan is approved, the borrower can withdraw the needed amount out of the total fund and leave the remaining balance with the bank. The interest is charged on the amount withdrawn by the borrower and not on the total sanctioned amount. Thus, customers can manage their monthly expenses without the fear of being burdened with EMIs.

In Line of Credit, the borrower pays a lower interest rate as compared to other loans. This mechanism is similar to credit cards where one has to pay the charges on the amount used and not on the total credit limit. If, for example, a bank sanctions Rs. 50,000 to a borrower based on the LOC application and from this amount he/she has taken Rs. 10,000 then the interest amount payable is only for Rs. 10,000.

Types of Line of Credit

There are two types of LOC available in the market and here is a brief description of each:

  • Secured - In secured LOC, the interest rate charged is relatively low. This is mostly because banks grant these loans against valuable assets taken as collateral or security. The borrower’s income is also taken into consideration other than the credit score before deciding on the rate of interest.
  • Unsecured – Under unsecured LOC, the interest charged is generally higher compared to secured LOC. This is because banks do not ask for any assets as collateral from the borrower. This means, the chances of repayment could be slightly lower and therefore, the interest rate is] high to cover for the risk of non-payment.

Application Process

The application process for LOC is very simple and straightforward. A borrower can visit the nearest bank and apply for it by furnishing the required documents. The bank then checks the borrower’s credit score and monthly income before granting the loan request. The total credit amount and the rate of interest are decided based on the credit score, monthly income, and collateral or security offered by the borrower.

Benefits of Line of Credit

There are many benefits associated with Line of credit. Listed below are some of them:

  • The interest rate charged on LOC is relatively lower as compared to traditional loans.
  • Borrowers can use a limited amount from the line of credit system. On the other hand, in other forms of loans, the borrower has to use the minimum amount pre-decided by the bank or lending institution.
  • Borrowers must pay the interest for the amount used out of the total credit limit. For the remaining amount, the bank does not charge any interest to the borrower.
  • Self-employed individuals will find LOC to be very beneficial since they can use the amount as per their needs and in a smaller quantity. This will also help them to start a business with limited risk.
  • LOC offers mental peace to business owners since it gives them access to a substantial amount of money which can be utilized as per the business needs and when the time arises.
  • Individuals who want to avoid personal loans due to high-interest rates can easily go for LOC and ensure that they have access to the required funds.
  • LOC generally comes with a very high credit limit as compared to the traditional loans where the amount offered is pre-decided by the bank and cannot be modified later.

In India, LOC can help in improving millions of lives especially those who do not have a fixed source of income. A lot of these people are in need of constant funds to meet expenses related to marriage, kid’s education, home refurbishment, etc. In such cases, since the required funds cannot be estimated, it becomes difficult for borrowers to gauge the amount they want to borrow.

Thus, with LOC, they can have the flexibility to access funds that are needed from the total approved credit limit. The borrower can enjoy additional benefits such as reasonable interest rates and payment of interest only on the utilized portion. Today, LOC can easily benefit many sections of the society in India by offering flexible funds at lower interest rates.

FAQs

1. How does a line of credit work?

Line of credit is very similar to the way credit cards function. There is a max amount available and interest is charged on the amount used. For instance, you can get a LOC approved for Rs. 50,000, but you can decide how much you wish to borrow (out of your credit limit). As you repay the principal balance, the available credit can be accessed up to the amount that the bank has pre-approved. The available credit limit can easily be accessed without the need to apply for a fresh loan.

2. Is there a specific limit that I can borrow up to in line of credit?

The maximum amount that you can source from a line of credit is decided by your bank and is also mentioned in the LOC agreement. The approved amount depends on factors such as your credit score, credit history, source of income, the purpose of use, etc. Once the bank approves and fixes your credit limit, you can have access to the entire funds and use as much as you need to meet your financial goals.

3. Can I use a line of credit for my start-up?

A start-up business can experience uncertain situations and may require funds in the initial stage. Sometimes, the funds can be arranged by accessing personal savings but when it comes to meeting investment needs, it has to look for other sources. Thus, since businesses are exposed to loss and emergencies, it is best to opt for LOC. This way, the borrower can limit his/her exposure in the business and funds can be used as per the business needs.

4. How do I choose the right bank for a line of credit?

There are many banks across India which offer Line of Credit. Borrowers must read the terms and conditions of the banks before making a choice and taking any final decision. Comparing the rate of interest across banks, visiting the bank branches personally, and making sure to read any undisclosed clause are some of the important steps to take while searching a bank. Most of the information is also available online. Ensure that the bank has a draft protection facility. An overdraft facility can help when you run out of money. Lastly, the charges of different banks for overdraft facility can be compared to ensure that the best option is selected for LOC.

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