Line of Credit - Eligibility, Criteria & Apply

There are many situations where a business may require emergency financial assistance. The most obvious one that comes to mind in recent times is the Covid-19 lockdown, where businesses had to shut down but still had to pay overhead expenses. The conventional lending mechanism like a business loan or a personal loan has many limitations.For one, banks and NBFCs only offer loans over a certain threshold amount. Smaller loan amounts are not available for borrowers who don't want a huge loan. Hence borrowers end up getting a big loan even if all they wanted was a fraction of the loan amount. Additionally, the interest applicable is on the entire loan amount, which results in increased interest outgo.So, what can one do to minimize these limitations? The answer lies in what is called a ' Line of Credit ' or LOC. A line of credit is specifically aimed at borrowers who require funds at frequent intervals, and hence businesses are the ideal users for such a product.Let us understand what a line of credit is in detail.

Just as the name suggests, a line of credit is a continuous mode of financial assistance wherein a borrower can borrow amounts at frequent intervals as per their needs. The applicant has to apply for a certain loan amount, and once it is approved, they need not borrow the entire approved amount in one go.They can withdraw only the funds that they presently require and leave the remaining balance with the lender. Then further down the line, if they require more funds, they can borrow an additional amount. The interest, in this case, is only applicable on the withdrawn amount and not the total loan amount approved.The main advantage of a line of credit is that the borrower has to pay lower interest as compared to conventional loans. Interest applicable for a line of credit is similar to how interest works for a credit card, where one has to pay interest on the used amount and not on the entire credit limit.Say, for example, a lender sanctioned a line of credit worth Rs. 100,000 to you, and you withdrew only Rs. 30,000, then interest will only be applicable on the Rs. 30,000 and not on the entire Rs. 100,000.

There are two types of lines of credit that lenders offer. A line of credit can be:

• Secured: A secured line of credit can be borrowed against valuable assets as collateral. Since security is involved, interest rates for secured lines of credit are also lower.
• Unsecured: An unsecured line of credit is sanctioned without any security or collateral. Since these are riskier for lenders; they might charge you a higher interest rate.

Applying for a line of credit is similar to applying for a loan. You can walk into a bank or NBFC and apply for a line of credit by filling out the application form and providing all relevant documents. The lender will evaluate your monthly income, credit score, past loans, repayment history, liabilities etc.The lender will then approve your line of credit request for a specific credit amount and interest rate, both of which will be based on your income, credit score and collateral if provided.

A line of credit has many benefits over a conventional loan. Let's look at some of these benefits below:

• The interest rates for a line of credit are usually lower than that of a business loan or a personal loan.
• In the line of credit, the borrower can use any amount they wish from the approved credit limit. This is quite unlike a regular loan, where the lender decides the total loan amount, and you have to borrow it in its entirety.
• The interest is only applicable for the withdrawn amount and not on the entire credit limit in a line of credit system.
• Small business owners and self-employed individuals can really find a line of credit beneficial since they can borrow smaller amounts as per their needs, thus limiting their risk and ensuring financial assistance at the same time.
• With a line of credit system, business owners can rest assured that finances will be available if and when they need it.
• Persons that want to avoid the high-interest rates for personal loans can always look at a line of credit for their business needs.
• An LOC comes with a high credit limit that can be used at any time, unlike a traditional loan where the amount is pre-decided by the lender, and one cannot modify it later.

1) How does a Line of Credit Work?

A line of credit works very similarto a credit card. The lender approved a maximum credit amount that you can borrow. But you need not borrow the entire amount. You can borrow only the amount you require and pay interest on it. The remaining balance will always be at your disposal.

2) Is there a specific limit up to which I can borrow in line of credit?

Yes. The lender decides your maximum credit limit based on your documents. You can withdraw as much as you want up to this limit.

3) Can I use a line of credit for my start-up?

Absolutely. A start-up or a new business requires constant financial assistance, and the first few years can be uncertain. A line of credit works best here since risks can be minimized by borrowing only the required amount.

4) How to choose the right lender for a line of credit?

Lines of credit are provided by many banks and NBFCs in India. Ensure you do your research and choose a lender that provides the best interest rate, has better communication, is accessible, and provides features like an overdraft facility. Apply for a line of credit with multiple lenders and choose the one that is offering you the best deal.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.