A line of credit (LOC) or credit line is a pool of money that you can borrow from a financial institution as and when required. These credit lines offer flexible options for borrowers and make for a comfortable repayment experience. They are almost similar to credit cards but do not require you to carry a physical card.
The traditional lending system has strict limitations on the minimum amount withdrawn. Moreover, borrowers need to pay interest on the entire loan sanctioned, which prevents them from withdrawing funds frequently. A LOC addresses all of these problems.
Now let us take a deeper dive into this unique system of borrowing.
A line of credit is a unique loan that allows borrowers to withdraw small to medium amounts as per their needs. Borrowers can take anywhere from Rs. 5,000 to Rs. 2,00,000 from their sanctioned loan and pay interest only on the withdrawn money over a specific time called the draw period.
The total money sanctioned depends on the borrower’s repayment capacity, creditworthiness, income, etc. Therefore, lenders evaluate their credit score, repayment history and other risk factors to decide their willingness to grant a loan.
Unlike traditional loans, interest on a credit line does not start until the borrower uses it. However, they do not have an obligation to do so. Borrowers need to make regular minimum payments to cover the interest payments on the withdrawn amount rather than the total loan. They can also choose to repay part of their borrowings.
Once the draw period is over, borrowers can no longer withdraw more funds. At this point, they must pay the outstanding principal amount and the rest of the interest by a fixed date. When the entire loan is repaid, the whole credit line becomes available for usage once again.
For example, let’s say Mr. Basu has taken a credit line of Rs. 5,00,000 and has withdrawn a total of Rs. 1,50,000 over the draw period. He has to pay interest on only Rs. 1,50,000 and the principal amount. After this, the whole credit line of Rs. 5 lakh becomes available again.
Also Read: Difference Between Credit Hard Enquiry And Soft Enquiry
Personal loans are unsecured loans that give you a fixed amount of funding that you can use for any purpose. These are offered in a lump-sum and thus, come with predictable interest and EMIs. Personal loans are best for large one-time expenses such as financing a high-value purchase, paying for a wedding, student loans or credit card debt.
Navi offers personal loans of up to Rs. 20 lakh for any need with interest rates starting at 9.9% p.a. You can download the Navi app and apply for a personal loan via a 100% paperless process.
On the other hand, a line of credit may be a secured or unsecured loan in nature with a credit line limit. You are liable to pay interest only on the funds withdrawn, and thus an LOC has a variable interest rate. Borrowers who are unsure about how much or when they need financing often choose this option. These carry higher interest rates than personal loans due to greater risks for the lender.
Also Read: How To Choose A Proper Personal Loan Tenure?
Line of credit offers a flexible option for borrowers who are not exactly sure how much funds they require. Like credit cards, they offer a revolving credit line, where you can withdraw funds as needed and pay the accumulated interest on the unpaid balance. They are best for funding ongoing and unpredictable expenses.
The following are some of the cons of using a line of credit:
Business credit lines are availed by various companies to address their working capital requirements, payment of salaries, inventory requirements, etc. These are not as flexible as a personal LOC as spending is limited to business-related expenses.
A personal LOC is offered to individuals with a high credit score (above 700) and a good debt utilisation ratio. Individuals can use this credit facility to meet their urgent or long-term expenses. Borrowers can pledge collateral to get better loan terms.
Yes, since small startup businesses are prone to losses and emergencies, an LOC is a great choice for them. Moreover, estimating a final value for how much funds a business requires is next to impossible. By having a credit line sanctioned, a startup can get access to instant cash during cash flow crunches.
Credit lines offer more flexible options for repayment over longer tenures compared to credit cards. They also come with lower interest rates than credit cards, which can charge anywhere from 36-42% for not paying dues on time. However, an LOC does not offer the convenience of credit cards, such as flexible transaction or repayment features.
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