What is a line of credit and how do I get one?  – Advisor Forbes INDIA
What is a line of credit and how do I get one?  – Advisor Forbes INDIA

Lines of credit are flexible loans granted by banks and other financial institutions. Much like a credit card, a line of credit (LoC) makes available a fixed or limited amount of funds for required use, as and when required. This must then be repaid over a predetermined period.

Like other forms of credit, interest will be charged for the funds. However, interest is only charged on the used amount of the line of credit and not on the total amount available. But the interest rate could be variable, depending on the lender and the market conditions at the time the funds are borrowed.

When to choose a line of credit

Lines of credit also work well when a person needs to undertake certain additional expenses over a period or months or may want to make purchases or ongoing payments. Generally, a line of credit does not require collateral. What is needed, however, is a healthy credit history or a good credit rating.

Also in the case of companies, a line of credit can be useful to get through difficult times, such as the pandemic situation in which we find ourselves. In such cases, banks and other lenders, such as non-bank financial companies (NBFCs), offer a line of credit of varying amounts and terms, depending on the borrower’s current circumstances.

Line of credit vs loans

For those who are still hesitant about the difference between a line of credit and a loan, a little elaboration will dispel all doubts.

Let’s look at the similarities first. Both are credit instruments to access a specific amount of funds, depending on the creditworthiness and eligibility of the borrower. In both cases, borrowers have to repay the loaned amount via monthly equivalent installments (EMI) or quarterly repayments.

Now let’s get to the differences. With regard to a loan, borrowers receive a lump sum amount all at once. There is a fixed (or, in some cases, flexible) interest rate on the specific sum borrowed for the duration of the loan.

If the borrower needs additional funds, this can only be obtained through another loan.

Conversely, a line of credit offers a predetermined maximum limit, which an individual or an institution can borrow depending on their situation. Therefore, borrowers can continue to take funds frequently, but only within the predetermined limit. Here, interest is only charged on the amount used.

Line of credit vs credit cards

Compared to credit cards, lines of credit are available at lower interest rates, making them a better borrowing proposition. They are also useful in situations where banks may not be interested in underwriting personal loans for many customers, as it is a form of unsecured debt.

Therefore, when unforeseen events arise, such as a medical emergency, sudden hospitalization, a short-term marriage, or may be the renovation of the house or its construction, the line of credit can be a good alternative.

How to use a line of credit

Now that the difference between loans and line of credit has been clarified, it is necessary to understand the period and the purpose when lines of credit are most beneficial.

As a general rule, lines of credit should not be used for one-time purchases like buying a car or a house, because car loans, home loans or mortgages do a better job when they serve these purposes. Although the line of credit can be used to acquire cars or houses, the interest rates do not make it a profitable solution.

In general, whether it’s individuals or entrepreneurs, a line of credit is the best way to manage the vagaries caused by variable monthly expenses or business income when it gets difficult. accurately assess the funds needed to meet their needs.

For example, freelancers, gig workers, or self-employed workers may have fluctuating or irregular monthly incomes. Additionally, there may be a delay in completing an assignment and ultimately in paying for the work. In these cases, the timing of payments is always uncertain.

Respond to recurring needs

While credit cards are the usual option for managing liquidity and cash flow issues, a line of credit is less expensive while offering more flexible repayment options.

Essentially, the line of credit is advantageous in circumstances that require recurring cash flow, with variable or unforeseen amounts or perhaps sellers are unwilling to accept payment by credit card or otherwise. The line of credit comes in handy in a situation that requires large cash deposits, such as weddings or family functions.

Home renovations and more

Likewise, lines of credit can be extremely useful during housing boom times when people are looking to remodel their residences or undertake other types of home renovations. Alternatively, home buyers can take out a home loan to buy the property and then get a line of credit to fund renovations or repairs.

Sometimes a personal line of credit may also be offered as part of a bank overdraft facility, although not all banks are willing to do this. This is an example, however, of how lines of credit can act as a source of emergency funding on an urgent basis, as needed.

How to check eligibility

Either way, potential borrowers should note that there is a specific credit assessment procedure whenever one approaches a bank or NBFC for a line of credit.

This is a simple and easy process that depends entirely on the type of financing sought and whether such a line of credit is available from a particular lender for this purpose or not. Many banks offer lines of credit for personal and business purposes.

The maximum limit of a person’s or business owner’s line of credit depends on eligibility and credit score, which determines creditworthiness. Thereafter, one must submit relevant KYC and financial documents, including bank statements.

Potential lenders will then check the applicant’s credit score and other related details before deciding on eligibility, maximum possible amount, term and other terms and conditions.

Advantages and disadvantages of the line of credit

The advantages of opting for a line of credit are multiple. These include:

  • Flexibility (specific amounts can be used from a predetermined credit sum without hassle).
  • Usually no hidden fees (even when you borrow frequently).
  • Higher loan amounts and its unsecured nature (no collateral or collateral is needed).

Keep in mind, however, that a borrower cannot exceed the sanctioned credit limit. Additionally, certain fees are applicable for using the LoC facility, which may vary between lenders and should be checked before opting for a line of credit.

Conclusion

When using a line of credit, always maintain budget discipline to avoid abuse, which can happen due to its ease of access. Additionally, borrowers should remember that it is difficult to easily qualify for a line of credit with a bad credit history. Even if they do, the interest rate could be surprisingly high.

The other point to note is that some banks may levy a maintenance fee (monthly or yearly) if the line of credit is not used during its sanctioned term. Nevertheless, for people with fluctuating monetary needs, a line of credit is a much cheaper and more durable option than credit cards or borrowing from unorganized lenders.

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