Whenever there is a financial emergency, people want quick funds to deal with the emergency. In order to cater to this, banks and other financial entities offer loans to meet the urgent needs of people who are in a bit of a financial pickle. A line of credit helps you during such a crisis and gives you funds ‘on demand’ that can help you with unexpected expenses.
What is a Line of Credit?
A line of credit (LOC) is a loan that is flexible from a bank or a financial entity. Like a credit card with a credit limit, a LOC is a set fund that you can use as needed and as you wish. You can repay the amount that you borrowed over time or immediately. You will have to pay interest only for the amount that you borrowed on the line of credit. After you have repaid the amount that you borrowed, the amount is available to be borrowed again. The key here is that it is flexible. You can take how much ever you want, whenever you want and repay it- as long as the terms and conditions are fulfilled.
There are two types of line of credit available. They are:
- Secured Line of Credit
The interest rate that is charged by the bank for this LOC type is relatively less. This is due to the fact that the bank offers the loan after holding your asset as collateral. Additionally, the borrower’s income and his/her credit score will also be taken into account before finalising the interest rate.
- Unsecured Line of Credit
The interest rate that is charged for this type of line of credit is usually higher compared to that of the secured LOC’s interest rate. The bank will not take the borrower’s asset to hold as collateral, therefore, it is unsecured in nature. Therefore, the repayment chances are on the lower side making the interest rate go up.
Advantages of Line of Credit
There are a lot of benefits that a line of credit offers. Some of them are:
- Cost-effective: As you only have to pay interest for the amount that you borrow and not for the credit limit, the interest paid will be less. You can use the axis bank personal loan calculator to get a rough estimate of the interest that has to be paid for the loan.
- High Flexibility: You can withdraw as much amount as you want up to the pre-approved credit limit.
- Low Rate of Interest: The interest rate that is applied on the loan amount is relatively lower than that levied by credit cards.
- High Credit Limit: According to your requirement and credit history, you can get approved for an increased credit limit. This will give you freedom to manage your finances as and how you wish to.
- Best for Financial Emergencies: You can access the amount from your credit line anytime, This feature is especially useful when you have a medical emergency or other financial emergencies.
- Great for Business Owners: New business owners constantly have financial emergencies and often do not have the funds to service these emergencies. While getting a business loan can be difficult, a LOC is the best option as it has high flexibility and low rates of interest.
Tips for Using a Line of Credit
- Assess All Expenses
When you get a LOC, there may be a few expenses or charges like late payment fees, processing fees, prepayment fees, etc that may be applied. Take all these into consideration before you apply for LOC to see whether you can afford the LOC.
- Compare the Interest Rates
Do you research and compare the interest rates of various lenders to make sure you choose the one that offers you the credit line at a low interest rate.
- Have a Good Credit History
A CIBIL score or credit score is a reflection of your credit behaviour. This score ranges from 300 to 900. A score above 750 is considered good for getting your loan approved. A low score indicates poor fund management and may cause your loan application to get rejected. The easiest way to increase your credit score is by paying your dues in time.
- Have a Rough Estimate of the Money you Need
Make sure to list down all the things that need financing. Prioritise which of these need financing first and then decide the amount that you want to borrow.
- Make Sure you Will be Able to Repay the Loan
Ensure that you have a plan for repayment before you borrow. Make sure that your income monthly is enough to repay the loan.
When Should you Not Use a Line of Credit
- If you have an unstable income and you know that you cannot afford payment, then a LOC will not be a great option. In case you have payment defaults, then your credit will suffer and in case of a secured LOC, the loan provider will take possession of the asset held as collateral.
- In case you know how much funds you need and do not want to use your assets as collateral, then you can opt for an unsecured personal loan rather than an unsecured LOC, depending on your credit history.
- In case you are using LOC for short-term expenses like vacation or for basic needs, it is a big red flag as this indicates that you are financially struggling and should not be taking a new loan.
Line of credit offers great benefits to business owners as well as self-employed people with an unstable income. People who do not have a stable monthly income are not preferred as a candidate for a loan. LOC is a blessing for such individuals who are in constant need of funds throughout the year. After the LOC gets approved, the individual can keep borrowing up till the credit limit. The best feature about this system is that he/she will be charged interest only for the amount that is withdrawn thereby bringing the interest down. This makes repayment easier for the borrower.