Line of Credit: A Complete Guide

A line of credit (LOC) is a flexible borrowing option that allows individuals or businesses to borrow funds as needed, up to a predefined limit. Unlike a traditional loan where the entire amount is disbursed upfront, a line of credit gives borrowers the flexibility to draw and repay funds multiple times, provided they don’t exceed the credit limit. Interest is only charged on the amount borrowed, not the entire limit.

A line of credit is ideal for managing fluctuating expenses, covering short-term financial needs, or maintaining cash flow for businesses.

Types of Line of Credit:

1. Personal Line of Credit: This type of credit is offered to individuals for personal use, including home repairs, medical expenses, or consolidating debts. It’s an unsecured form of credit, meaning no collateral is required.Key Features:
   • Borrower: Individuals.
   • Collateral: Usually not required.
   • Interest Rate: Varies from 10% to 24% p.a., depending on the lender and borrower’s creditworthiness.
   • Limit: Based on credit score, income, and financial history.
2. Home Equity Line of Credit (HELOC): A HELOC allows homeowners to borrow against the equity of their home. The home acts as collateral, making it a secured line of credit. HELOC is commonly used for home renovations, large purchases, or emergencies.Key Features:
   • Borrower: Homeowners.
   • Collateral: The home.
   • Interest Rate: Starting from 7% to 10% p.a..
   • Limit: Typically up to 80% of the home’s market value, minus any outstanding mortgage balance.
3. Business Line of Credit: This is designed for businesses to manage cash flow, cover operational expenses, or fund short-term projects. Businesses can draw funds as needed and repay over time. Business lines of credit can be secured or unsecured, depending on the lender and the business’s credit profile.Key Features:
   • Borrower: Small to medium-sized businesses.
   • Collateral: Optional, depending on the lender.
   • Interest Rate: Starting from 8% to 18% p.a..
   • Limit: Based on business revenue and creditworthiness.
4. Credit Card Line of Credit: Technically, a credit card functions as a revolving line of credit. You can spend up to your credit limit, and you only pay interest on any unpaid balance after the billing cycle. This form of credit is best suited for everyday purchases and smaller short-term borrowing needs.Key Features:
   • Borrower: Individuals.
   • Collateral: None.
   • Interest Rate: 24% to 42% p.a. (varies by card issuer).
   • Limit: Based on the individual’s credit score and financial history.

How a Line of Credit Works:

• Credit Limit: This is the maximum amount you can borrow, set by the lender based on your financial profile. The limit remains fixed unless reviewed by the lender.
• Borrowing and Repayment: You can draw money as needed, up to the credit limit. Once you repay the amount borrowed, the credit becomes available again. You are only charged interest on the amount you have borrowed, not on the full limit.
• Interest Rates: Interest is typically charged on the amount of money borrowed, and rates can either be fixed or variable. Lines of credit often come with lower interest rates than credit cards, especially for secured credit lines.
• Fees: Some lines of credit come with fees, including annual fees, transaction fees, or early repayment fees. It’s important to review the terms before applying.

Advantages of a Line of Credit:

1. Flexibility: You only borrow what you need, making it ideal for managing variable expenses.
2. Interest on Borrowed Amount: Interest is charged only on the amount you’ve withdrawn, not on the entire credit limit.
3. Revolving Credit: Once you repay the borrowed amount, the funds become available again for future use without needing to reapply.
4. Quick Access to Funds: You can access funds quickly without going through a lengthy application process each time you need money.

Disadvantages of a Line of Credit:

1. Variable Interest Rates: Many lines of credit have variable rates, which can rise over time, leading to higher interest payments.
2. Temptation to Overspend: Since it provides easy access to funds, borrowers may be tempted to use more credit than they can comfortably repay.
3. Credit Score Impact: Overborrowing and missing payments can negatively impact your credit score.
4. Fees: Some lines of credit come with hidden fees, such as maintenance fees or fees for inactivity.

Line of Credit from Indian Banks and NBFCs:

Indian Banks:

1. State Bank of India (SBI):
   • Personal Line of Credit: Offers a loan against securities and overdrafts.
   • Interest Rate: Starts from 10% p.a..
   • Limit: Based on the value of securities pledged or income.
2. HDFC Bank:
   • Smart Line of Credit: Allows individuals to borrow funds against shares or mutual funds.
   • Interest Rate: Starts from 11% p.a..
   • Limit: Depends on the securities pledged.
3. ICICI Bank:
   • Business Line of Credit: Provides working capital solutions for small and medium enterprises (SMEs).
   • Interest Rate: Starts from 10% p.a..
   • Limit: Based on business turnover and financial health.
4. Axis Bank:
   • Personal Line of Credit: Available for salaried individuals for managing personal expenses.
   • Interest Rate: Starting from 12% p.a..
   • Limit: Based on salary and financial profile.

NBFCs (Non-Banking Financial Companies):

1. Bajaj Finserv:
   • Offers a Flexi Loan where you can draw funds as needed and pay interest only on the amount utilized.
   • Interest Rate: Starting from 12% to 15% p.a..
   • Limit: Based on income and creditworthiness.
2. Tata Capital:
   • Provides a Business Line of Credit for SMEs to manage working capital needs.
   • Interest Rate: From 10% to 14% p.a..
   • Limit: Depends on business turnover and assets.

When Should You Use a Line of Credit?

A line of credit is best used for:

• Managing irregular or fluctuating expenses, such as home repairs or business working capital.
• Emergencies where you may not know the exact amount needed upfront.
• Projects where funding needs may arise over time, such as renovations or business expansion.

Conclusion:

A line of credit is a flexible financial tool that offers the convenience of borrowing as much or as little as needed, as long as you stay within the credit limit. It’s perfect for those who need ongoing access to funds but don’t want to commit to a lump sum loan. However, it’s important to use this facility wisely to avoid overspending and accumulating high-interest debt. Before opting for a line of credit, compare the terms offered by different banks and NBFCs to find the best deal suited to your needs.