Whenever a financial requirement arises, the first option that most people turn to is a traditional loan. With traditional loans, a one-time lump sum amount is offered by the lender that is paid out by the borrower in monthly installments, known as EMIs. However, while there are several benefits to traditional loans, they come with certain limitations as well. To that end, financial institutions offer another lending product known as a line of credit that is relatively less known but offers its own share of advantages over traditional forms of loans in the market.
It is easy to understand the line of credit as it essentially works a lot like a traditional loan but with a few key differences. With a line of credit, the borrower can avail a specific loan amount from the lender, much like traditional loans. However, the borrower is not required to take the entire loan amount in a single go and can instead take from the funds as and when required. The interest for a line of credit loan is charged only on the part of the loan amount taken out by the borrower instead of on the entire amount itself.
A line of credit loan comes with a series of useful features that can be highly useful for a borrower. These include:
Across the board, the interest rates levied on line of credit tend to be lower than that for personal loans.
The borrower is also expected to only pay interest on the part of the loan that he or she has taken out, instead of the entire amount.
A line of credit also allows an individual to borrow a minimal amount of credit, which is not typically possible with traditional loans that come with a requirement of a minimum loan amount.
Due to its unique features, line of credit is suited for some specific purposes such as:
A line of credit loan can be a useful financial tool for self-employed individuals who can fund the needs of their business without taking on too much risk.
Similarly, it is useful for professionals who don’t have a regular source of income and require funds at regular intervals to survive low-business periods.
Line of credit is also useful in helping to consolidate small debts.
They can be useful for personal financial requirements such as funding a wedding or renovating your home.
It is also useful for all individuals from all backgrounds to financially meet various medical requirements that are urgent in nature.
Line of credit typically comes in two types of forms. These are:
As is the case with secured traditional loans, a secured line of credit requires security or collateral from the borrower. This means that the borrower is required to pledge an asset, such as a house, car or stocks, against the loan amount availed by him or her.
An unsecured line of credit does not require the borrower to pledge any of his or her assets as collateral or security. In this case, the creditworthiness of the borrower becomes important which is why lenders typically turn to his or her credit history. It is recommended to have a credit score of 750 or above to avail line of credit at the best possible interest rates and terms.
One of the most common types of line of credit availed by borrowers is the personal line of credit.
A personal line of credit is a type of credit option that is designed to be used by a particular individual. In this way, it operates much like a credit card in that a loan limit is predetermined and the borrower can take out amounts from this fund as and when he or she chooses. As mentioned above, the interest payable by the borrower is charged on the amount of money taken out by them, instead of on the entire loan amount.
Another commonly used form of credit is the business line of credit, which is specifically designed to cater to the needs of a business.
As with traditional business loans, a business line of credit comes with a predetermined loan amount. However, unlike business loans, this loan amount works as a loan limit from which the business can withdraw regular funds as and when it requires them. In this way, the ever-changing needs of a business are promptly met and the business manages to keep a healthy cash flow at all times. Business line of credit can be availed to meet not just one but several types of business needs, be it expansion, inventory, or equipment purchases with just one form of credit.
Another form of line of credit is the revolving line of credit. Like all forms of credit and the other types of line of credit, revolving line of credit also comes with a predetermined loan limit. However, what sets it apart from other forms of credit is that once the debt is paid up in a revolving line of credit, the borrower can again borrow up to this loan limit without having to go through another process of loan approval. The borrower can therefore keep withdrawing, repaying and re-borrowing against the loan limit multiple times for as long as the agreement for the line of credit lasts. As long as the borrower is careful with the repayments, the evolving line of credit can be incredibly useful for both individuals as well as businesses.
A line of credit loan can be availed by a borrower through a number of banks and financial institutions. The only thing to keep in mind is that you must fulfill the formalities as well as documentation requirements set out by the specific lender.
Some of the most commonly required documents for a line of credit include:
An identity proof, such as Aadhaar, passport etc.
A few income proofs, such as Form 16, ITR Returns etc.
A few address proofs, such as electricity bills, passport
Bank statements for the past 6 months
Once the documents are submitted, they will be verified and the lender will proceed to look over your credit history and credit score. Based on these factors, an applicable interest rate will be offered to you along with the line of credit facility. It is important to note that lines of credit can be applied for through both online and offline modes.
Here are a few points on how a line of credit differs from a traditional loan:
With a traditional loan, the borrowed amount is disbursed entirely, but with a line of credit, the amount is withdrawn in installments as and when required by the borrower.
With traditional loans, the payable interest is calculated on the entire borrowed amount, but with a line of credit, the payable interest is calculated only on the amount that is withdrawn by the borrower.
Traditional loans come with specific regular periods of repayments known as EMIs, but with a line of credit, there are no such fixed periods.
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The interest calculated on a line of credit is calculated not on the entire principal amount, but only on the specific amount that is withdrawn by the borrower from the principal amount. Therefore, the interest is calculated on a daily rather than a monthly basis (as is the case with EMIs).
For the most part, line of credit loans are ideal for a wide range of financial purposes. However, it is recommended that when it comes to making big, one-time purchases such as a house, borrowers refrain from using a line of credit for the same. It is much more convenient to avail a loan for the same purpose.
A line of credit can be availed through banks and financial institutions after filling out their applications - online or offline - and fulfilling their documentation requirements. These typically include submitting identity proofs, PAN Card, few income proofs, address proofs, and previous bank statements.
Individuals with bad credit can have a difficult time getting approved for a line of credit. Moreover, even if they do get approved, the interest rates applicable will certainly be higher than for individuals with good credit. Consider taking steps to improve your credit history and credit score.
It is most likely going to be difficult to get a loan approved with a 450 credit score since most financial institutions typically require a credit score of 650 or above. While there is a possibility to get approved with a score of 450, it is recommended to improve your credit score to enjoy the best interest rates possible on the disbursed loan.