Line Of Credit: Definition, How It Works, Types, Benefits And How To Apply

Personal Loans

A line of credit (LoC) is an open-ended loan that you can borrow from financial institutions during a financial urgency. The lenders determine the total loan amount depending on your creditworthiness. And, you as a borrower, can have access to this total loan amount at any given time. To know the line of credit types, benefits, how to apply, disadvantages and useful tips, keep reading!

What is a Line of Credit?

A line of credit (or credit line) is an account which acts as a pool of funds from which you can borrow money as and when required within a pre-set credit limit. Borrowers can withdraw money at their convenience and repay it within the repayment period. Interest is charged on the amount that one has utilised and not on the total loan amount. 

How does a Line of Credit Work?

After a borrower applies for a line of credit, the financial institution will check whether he is eligible to avail of a credit line or not. The main eligibility criteria are a good CIBIL score and stable income. 

After a borrower qualifies for a credit line, there will be a set period called the ‘draw period’. The borrower can withdraw money from the LOC (Line of Credit) account during the draw period. As per a borrower’s convenience and need, the financial institution will transfer the money via card, cheque, or account transfer. 

After a borrower starts withdrawing money, interest starts getting accrued. Once the borrower starts making repayments, the amounts repaid will be added to the LOC account. After the end of the draw period, the repayment period will start. The borrower will have to repay the remaining balance if applicable.

Also Read: Difference Between Credit Hard Enquiry And Soft Enquiry 

Types of Line of Credit Loans

• Unsecured Line of Credit: This is also known as a revolving credit account. The financial institution sanctions an unsecured credit line after checking a person’s credit score and income. One doesn’t need to pledge any collateral to avail of it. However, the interest rate is high because the borrower doesn’t have to pledge assets.
  Unsecured Line of credit can be further divided into the following:
  • Personal Line of Credit: Individuals opt for it to finance their personal expenses.
  • Business Line of Credit: Business owners avail of this loan to meet their business requirements.
• Secured Line of Credit: When a borrower avails of a loan of credit against collateral, it is known as a secured credit line. In such cases, failure to repay would be followed by liquidation of the assets. 
• Revolving Line of Credit: In this case, borrowers get access to a certain amount of funds that they can borrow again once they repay the total amount. This makes it an excellent option for those looking for flexible credit to fund ongoing projects or their business’s expenses.  
• Non-revolving Line of Credit: Like traditional loans, this LOC does not increase the credit after payment. You have to apply again for a non-revolving credit line after full repayment. Its main advantage is that it is less stringent with regard to credit score requirements.

Benefits of Line of Credit

• You can borrow only the amount you require without having to pay interest on the entire credit line. 
• Borrowers can get flexible repayment options for the principal amount on LOC as long as they pay the interest and other fees.
• Some financial institutions offer the option of secured LOC, which has lower interest rates.
• LOCs can be approved for use over a long tenure of up to three years. During this time, customers can redraw their limits multiple times without incurring additional charges.
• These are ideal for long-term projects with a wide range of unpredictable costs. Also, a LOC is useful to address short-term cash shortages.
• The interest rates for LOC are usually lower than those offered by credit cards, payday loans or cash advances.
• Borrowers can get access to a credit line in a few minutes, making it an ideal option for those who cannot get access to credit cards.

How to Apply for a Line of Credit

Given below are the steps to apply for a line of credit:

Step 1: Visit the nearest branch of your chosen lender

Step 2: Fill up the required form and attach the necessary documents

Step 3: The bank will check your credit score and income and deem your worthiness

Step 4: The bank will sanction the LOC after you qualify as worthy 

Differences between Line of Credit and Personal Loans

The table below provides the differences between a credit line and a personal loan:

Also Read: Personal Loan vs Credit Card: Which One Should You Opt For

Tips – To Use or Not Use a Line of Credit!

During a financial crisis, consider these crucial tips before you decide to use or not use a LoC.

When to Use a Line of Credit:

• One can use this loan to pay off small debts.

• A person might choose to avail of a credit line to finance major expenses like education costs and home renovation. 

When Not to Use a Line of Credit:

• A credit line is not a good idea if the borrower has an unstable source of income

• If the borrower is sure of the requisite amount but doesn’t want to pledge his assets, then a personal loan might be a better option than a LOC.
• If one needs to borrow money to meet his daily needs, he shouldn’t seek a LOC as it won’t be a good idea to have new debts.

While a line of credit is helpful, there are a few disadvantages too. Check out what they are in the following section.

Disadvantages of a Line of Credit

• Borrowers may face difficulty in repayment if interest rates increase.
• Registration fees are applicable.
• LOC is a liability that can restrict the borrower from availing of another loan.
• Resisting the temptation to splurge is difficult because money is readily available.

Final Word

A line of credit is a flexible loan option beneficial for the borrowers and the lenders. You can choose to avail of a secured or unsecured credit line based on your need. The terms and conditions associated with a LOC are convenient and repaying the loan will not be an added burden. However, you must have a good credit score to apply and avail of a credit line. 

If you need cash urgently and do not have time to apply for an LoC, apply for a hassle-free Navi Personal Loan. Download the Navi app and get the loan credited to your account directly.

FAQs on Line of Credit

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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article. 

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