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 The best part is the line of credit interest rates will only be charged on the amount withdrawn by the borrower and not on the entire credit limit sanctioned by the lender.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.

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 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 transfer 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.

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. 

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).

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 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 an 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 balances can reduce credit scores.