Today, the lending market has a lot of options to suit different customer needs. From banks to NBFCs to private lenders including online and mobile lenders, innovation has touched upon the finance sector too. There are usually two types of borrowers – those who borrow for personal use, and those who borrow for business. Both personal and business needs can often be unpredictable and large. At this time a line of credit comes to the rescue.
What is a Line of Credit And How Does it Work?
A line of credit is a pre-specified, limited pool of money. You can borrow it as and when needed, and can repay immediately or over a specified time period. It differs from traditional loans. The entire loan amount is not disbursed at one go. The full amount is only made available to the borrower. The borrower can then withdraw the required amount. The interest is charged only when the required amount is “drawn”. In short, it works something like a credit card where you can draw on the credit when you need to pay for something that is financially out of your reach.
How do You Get a Line of Credit?
A number of banks offer credit line for both personal and business loans. Eligibility for a line of credit depends mainly on the credit worthiness of the borrower. Therefore, a number of financial documents that include credit scores will be assessed by the lender.
Types of Credit Lines
Line of credit loans can be unsecured or secured. Secured ones require you to keep an asset as collateral and the interest rate is often lower than an unsecured credit line. Unsecured ones are provided without a collateral backing and generally have higher interest rates. Other lines of credit for specific purposes are:
- Home Equity Line of Credit (HELOC): A secured credit line backed by the home owned by the borrower. It is available for a set time period. This “drawing period” is about 10 years, after which the borrower must make full payment. HELOC is often used for home repayments, improvements, emergency fixes etc.
- Business Line of Credit: Often used to better working capital and cash flows, this is usually a secured short-term loan backed by the business assets (machines, inventory etc.). It is often used for immediate business activities like purchasing inventory, paying operating expenses, or buying new equipment.
Advantages of Line of Credit
- Flexible: By opting for line of credit, you can be eligible for a large credit amount, but need not utilise it all. You need to pay interest only on the amount you borrow or draw, and not the entire approved loan amount. Also, repayment terms can be flexible, from part payments to lump sum.
- No charges for drawing money: There are generally no charges for withdrawal of funds.
- Higher account limit: Although the loan functions similar to a credit card, a credit line comes with a higher account limit than a credit card. This makes it favourable for tackling large expenses such as weddings.
- Unsecured: Most line of credit loans are unsecured i.e. no collateral backing is required to take a line of credit loan. So even if you do not have the financial backing, you can start your business or pay over your personal commitments easily by making use of a line of credit.
- Lower interest rates: Despite being similar to a credit card, the interest rate is often much lower, making a line of credit a cheaper credit option.
Disadvantages of Line of Credit
- Revolving Cycle: A line of credit works like a revolving account, and if you do not keep track of the repayment amount due, it is easy to lose track and keep drawing from the account (despite the specified limit).
- Stringent Approvals: A line of credit is approved only after checking credit worthiness, hence those with poor credit history may find it impossible to get one.
- Closing And Maintenance Costs: Some banks may issue closing costs to close down a line of credit or maintenance charges to keep them running. Check for these to minimise extra expenses.
A number of online money lenders provide lines of credit for both personal and business use. Make sure you make the best of this flexible service, by taking an informed decision to get one.