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Line of Credit

At the time of any financial crisis, people look for access to instant funds to deal with the arising monetary need. To cater to these unexpected or urgent financial needs of people, banks, non-banking financial companies (NBFCs) and other financial institutions provide loans to help them meet their immediate financial requirements. 

However, due to certain limitations of the traditional lending system, banks have to maintain a minimum limit on the amount below which they cannot offer a loan. This means whether the borrower is in need of a certain amount or not, they have to borrow at least the minimum loan amount specified by a particular bank.

For instance, you need a loan of Rs. 50,000, but the bank with which you are applying for the loan does not offer a loan amount below Rs. 1 Lakh, you are bound to apply  for a loan of Rs. 1 Lakh even if you don’t need it. Apart from getting the unwanted additional loan amount, you will also have to pay the interest on it.

To solve this issue, banks introduced an easy solution and named it as the Line of Credit (LOC).

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What is Line of Credit?

A line of credit meaning a preset borrowing limit that a borrower can avail of at any time. Under LOC, the borrower can withdraw the approved loan amount whenever needed as long as they do not exceed the given maximum credit limit set in the agreement. As the borrower repays the money, it can be borrowed again if it is an open line of credit. The best part is the line of credit interest rates will only be charged on the amount withdrawn by the borrower and not on the entire credit limit sanctioned by the lender. This reduces the overall interest burden as the borrower has to pay a low interest rate in this lending system compared to a traditional loan. In simple words, LOC is like a credit card where you have to pay the charges only on the amount used and not on the entire credit limit. Line credit is extremely beneficial for those who are in need of financial aid at regular intervals.

How Do Lines of Credit Work?

A line of credit provides you access to a preset amount of money that can be borrowed when you are in need of it. However, you do not have to pay any interest until you actually borrow the amount. There are business lines of credit, but here we will discuss the lines of credit for personal use.

Personal LOC is usually unsecured, which means you don’t need to provide collateral to avail of the line of credit. For secured LOC, the loan is offered against a collateral, such as your house, savings account, etc.

When you apply for LOC, having a better credit score could help you qualify for a low interest rate. Some lines of credit may involve some fees, such as an annual fee, and a limit on the amount you can borrow.

After you are qualified for the LOC, you will have a set time frame, also known as the “draw period”, in which you can withdraw money from the line of credit account. The draw period can go on for several years. The lender may also give you special checks or a card to use or transfering the money to your checking account, whenever you are ready to borrow the money.

When you borrow money from the line of credit given to you, usually the interest starts to accrue and you will have to start paying at least the minimum payment, the amount of which is added back to your available bank line of credit as you make payments.

Once your draw period ends, you will then enter the repayment period, under which a set time to pay off the remaining balance will be given to you. Please note that making only minimum payments can cost you more interest in the long run.

Types of Line of Credit

There are mainly two types of lines of credit as explained below:

  • Secured LOC: Under this LOC type, the interest rate levied by banks is relatively low because banks offer loans against the borrower's valuable assets as security. Apart from the value of the asset being offered as collateral, the lender will also consider the income and credit score of the borrower before deciding the final rate of interest. Home equity line of credit (HELOC) is one of the examples of secured LOC. Home equity loan rates are low as they are secured against the market value of a home. It is considered the best line of credit.
  • Unsecured LOC: Under unsecured line of credit loan, the interest rate charged by the banks is higher than that for the secured LOC. That is because being unsecured in nature, lenders cannot take the borrower’s asset as security and so, the chances of repayment are slightly lower in this type of credit, which increases the rate of interest consequently. 

How to Apply?

The process to apply for the line of credit is very simple. All you need to do is walk into your bank with all the required documents and apply for the LOC. The bank will scrutinise your credit score and net monthly income before approving your loan request. The final credit limit and the rate of interest will be based on your CIBIL score, monthly income, and security offered (for secured LOC).

How to Track Your Line of Credit?

Your Line of Credit can easily be tracked from the monthly statement sent to you by the bank. The bank can send you the statement through various modes, in this digital banking era.

Most banks usually prefer to send e-statements via email to your registered email id. Make sure to check your statements monthly or quarterly, whichever mode was opted by you, to keep a track of the same.

Check the remaining balance or limit before you apply for any new loan as it is necessary to clear your outstanding dues before getting a new loan. You can reach out to the bank through their customer care number at any point in time to get all the details if you have any confusion.

Pros and Cons Line of Credit

Pros of Line of Credit

  • Borrow only the amount you need.
  • Line of credit interest rates are low and are incurred only on borrowed funds only.
  • There is constant access to funds.
  • Best financial option to meet temporary cash shortfalls.
  • Availability of flexible repayment options.
  • No collateral to be risked for an unsecured open credit line. 
  • Lower average Annual Percentage Rate (APR) than credit cards.
  • Secured LOC gives the option to provide collateral for getting lower interest rates.
  • An ideal credit facility for long-term projects wherein the final costs are variable.
  • You can draw up to 100% of your credit limit without any restrictions.

Cons of Line of Credit

  • If there is an increase in interest rates, the variable rate on the LOC also increases.
  • Non-deductible interest expense.
  • Annual or monthly maintenance fee is to be paid regardless of use.
  • It may be more difficult to forecast the charged interest amount.
  • Higher interest rates than fixed-rate loans makes it a bad alternative for debt consolidation.
  • Fees or APRs charged by providers vary widely. 
  • It usually requires account opening at the lending institution.
  • Not an ideal solution for long-term cash shortfalls.
  • You must have a good credit score to qualify.
  • There is a temptation to spend because of ease of access.
  • Consistently high balance can reduce credit score.

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Line of Credit FAQs

How will a line of credit impact my credit score?

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When you apply for a line of credit, lenders may perform a hard inquiry on your credit reports which can temporarily lower your credit score by a few points. After approval and your acceptance, it appears on your credit report as a new account. Never using your available credit or using a small percentage only can lower your credit utilisation ratio (CUR) and improve your credit score. Borrowing a high percentage from the available credit limit or making late payments can increase the CUR and impact your credit score negatively.

What is the repayment process of LOC?

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Repayment process for LOC is the same as a credit card. After taking out some amount of your credit limit, a deadline for repayment will be set. In the meantime, if you need some more funds before the repayment of your first loan, you can get it without any hassle. In LOC, you are required to pay interest for only the amount used and not for the entire credit limit sanctioned to you by the bank. You can make repayment easily in EMIs (principal + interest) once the deadline is set.

Who should avoid getting a LOC?

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Line of Credit or LOC is a great option for those who want to meet their financial requirements by paying a low-interest rate and are often in need of a loan. However, it must be utilised wisely to help you reap the maximum benefit. If you are not a disciplined borrower regarding financial matters or if you are not confident about your repayment ability, it is better to avoid LOC. The line of credit is like a credit card. It is a blessing for those who can use it wisely. It can turn into a nightmare if you use itin a wrong way.

What is HELOC?

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HELOC or Home Equity Line of Credit is the most common variant of secured LOC. HELOC is secured against the market value of the house minus the amount owed. This becomes the basis for deciding the size of the LOC. Being a secured LOC, the home equity loan interest rates are lower than unsecured LOC. Typically, the credit limit in home equity loan is equal to 75% to 80% of the home’s market value minus the balance owed on the mortgage. You can make the home credit loan payment online. To avail of this facility, you must have a HELOC account with the lending bank.

How can the Line of Credit improve the people’s life in India?

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The Line of Credit can offer remarkable benefits to the business professionals or self-employed individuals who do not have stable monthly income. Because people with unstable monthly income can be scorned off by the banks and are usually not considered eligible for a loan. LOC is a blessing for individuals who need constant money throughout the year. Once the loan gets approved, you can withdraw the amount that you need to meet the existing requirement. The best thing about LOC is the interest will be charged only for the amount actually used regardless of how much limit was sanctioned to the borrower. This makes repayment easier as the borrower can select the repayment tenure and conveniently repay the amount along with monthly line of credit interest rates.

In India, LOC can play a vital role in improving people’s lives, usually of individuals with a low or unstable income source. These individuals need a constant flow of money to back up many events or requirements, like marriage in the family, child’s education, home construction, repair, and so on. In such situations, the required amount is uncertain, so it becomes difficult to decide how much amount you want in the first go. With LOC, they have the flexibility to withdraw any amount they want from the sanctioned credit limit. The borrower can enjoy other benefits as well, such as low interest rate compared to the traditional loans. If LOC becomes accessible to all sections of the Indian society, it will surely change the lives of people to a great extent.

Which LOC is the best?

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Home equity line of credit or HELOC is the best LOC available in the market. Home equity loan interest rates are low as they are secured against the home equity or home’s market value. You can search for and apply for the best home equity loans online through our website. We provide HELOC mortgage at best interest rates.

What is the warehouse line of credit?

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A warehouse line of credit is a credit line or a short-term revolving credit facility provided to mortgage bankers by a financial institution for the funding of mortgage loans.