What is Line of Credit
The line of credit represents an arrangement between a customer and a crediting institution, typically a bank, establishing a maximum loan balance to be maintained by the borrower. With this instrument, the clients are permitted to draw down at any point of time, but they should not exceed the maximum, specified in the agreement. Lines of credit come with some advantages over regular loans, with the interest rate not being charged if the credit line is left unused. Moreover, one can borrow when money is needed. Depending on the requirements of the crediting institution, the credit line may be provided in the form of demand loan. In this case, if there is an outstanding balance, it has to be repaid immediately at the request of the financial institution.
Credit lines are basically sources of credit extended to individuals, business enterprises, and government and non-government institutions. Lines of credit can be of several types: export packing credit, demand loan, overdraft protection, purchase of commercial bills, discounting, term loan, and others. In basic terms, they represent bank accounts that are to be tapped readily at the discretion of the borrower. He or she pays interest only on the amounts withdrawn. In addition, the credit line can be unsecured or secured by collateral.
Very often, lines of credit are granted to creditworthy clients who experience liquidity problems. In this case, the borrowing instrument is referred to as a personal line of credit. This term is also employed to denote the customer’s credit limit which is the maximum allowed credit the customer can borrow.
The cash credit represents a form of credit with a short term
, extended to a company. Banks
provide such type of financing only against collateral required to secure the borrowing. With the security being provided, the recipient of the loan is permitted to draw continuously from the bank. However, there is a set limit specified by the lender.
Home equity lines of credit
are types of revolving credit where one’s home guarantees the loan. With real estate
being among the most valuable assets, the majority of home owners will request a home credit line only for big items such as emergency medical bills, home improvements, college education, etc. A home equity line of credit is not and should not be used to cover one’s day-to-day expenses.
With this type of borrowing instrument, one is approved for a specified amount. Most creditors will set the line’s credit limit by taking a certain percentage (for example, 75 percent) of the property’s appraised value and deduct from it the outstanding balance on the existing mortgage.
On determining one’s credit limit, the creditor will take into account one’s capacity to repay the borrowed amount (both, interest and principal). The lender will look at one’s income, repayment history, amount of debt, and financial obligations to different lenders. When the client’s application is approved, the client borrows at his or her convenience. Normally, one uses special checks to draw on the credit line. Other means can be used under some plans, and there may be a requirement to borrow a minimum amount whenever drawing on the line.