Understanding Line of Credit (LOCs)

Most people often seek traditional loans from banks, use credit cards or borrow from friends or family when in need of money. In recent times, specialized peer-to-peer or social lending sites have become popular spaces for lending on the web. In the direst of circumstances there are pawnshops and payday lenders that borrowers can go to.

However, the best and probably the wisest choice would be to take a line of credit from a bank or NBFC. A personal line of credit, like credit cards, is a revolving credit account that allows individuals to borrow money to a preset limit. These funds can be used for any purpose you see fit. While lines of credit do not allow withdrawing of money at one go, they come at a lower interest than personal loans and credit cards. 

If you’ve been searching for ‘line of credit meaning’, then this article is for you. Let us now understand in detail about the line of credit and how it works.

Suggested Reading: Top 10 best credit cards in India

When Is a Line of Credit Beneficial?

Due to the flexible nature of lines of credit and the fact that they are typically not used for one-time purchases such as houses or cars, lines of credit can be helpful for acquiring items for which a bank might not normally underwrite a loan.

Typically, lines of credit are used to smooth out fluctuations in income and expenses or to finance projects where it is hard to predict exactly the amount needed.

Types of Lines of Credit

A line of credit can be categorized into two types: secured and unsecured lines of credit. 

Secured Line of Credit:

 A secured line of credit is backed by collateral, such as a vehicle, a home or another asset, and typically carries a much lower interest rate than an unsecured line of credit. In case you fail to repay the borrowed amount, the lender can liquidate your assets to cover the losses. 

Unsecured Line of Credit:

An unsecured line of credit is not backed by collateral and carries a higher interest rate to account for the greater risk associated with lending to someone who does not have substantial assets to protect against default. The lender extends this based on your eligibility and the policy they follow. 

Unsecured Line of Credit is further divided into:

• Personal Line of Credit

• Business Line of Credit

Personal Line of Credit: This facility is generally employed by customers for urgent requirements or to fund big purchases, home renovation, education and other financial requirements.

Business Line of Credit: This is commonly availed by businesses to meet their expenses for working capital requirements, paying wages, inventory and more.

Advantage of Lines of Credit

A line of credit charges interest only on the amount used by the consumer, not on the entire amount available to the consumer

As long as interest and fees are charged, consumers can repay the line of credit principal at their convenience. Consumers can generally redraw within their limit multiple times without additional fees

A line of credit can be approved once and used for a long period of time, usually three years. In addition, it contributes to boosting your credit score

Disadvantage of using Line of Credit:

It may be unnecessary to pay maintenance fees or annual fees if you rarely use the service.

Although a line of credit may appear more expensive than a personal loan at times due to its interest rate flexibility, the actual cost to the consumer may be less

There are not many financial institutions that offer lines of credit, so a consumer may have difficulty understanding the product.

Borrowing is always a serious matter and the obligation to repay must be taken seriously. Therefore, given the fact that loans are easily available via a line of credit, it might lead to unnecessary expenses and interest cost if not used wisely.