A Line of Credit is a borrowing option where you are approved upfront for a set credit limit that you can draw on whenever you want. It is an agreement between a financial institution, like a bank, and that bank’s client, with the bank determining the credit limit. You are not charged interest on the full credit limit. Only the amount you borrow is subject to interest. You could borrow, then pay it down, then borrow again and again as long as you do not exceed your total approved limit.
How Do LOCs Work?
Lines of credit can be obtained through a bank, credit union or other financial institution. The money becomes accessible quite fast after application and approval—generally the next working day. When it comes to business lines of credit, the lender looks at profitability and other business indicators to determine the viability of your company and its capacity to repay the loan.
The funds are revolving credit, similar to a credit card, in which you just have to pay back the amount you used. Keep in mind that the amount of your monthly payment will vary depending on the balance and remaining term on your line of credit.
What is the Difference Between Unsecured and Secured LOCs
Secured and the Unsecured LOC are the two main types of Business LOC’s. The secured Business LOC requires businesses to provide collateral to secure financing, the collateral typically is an asset that the lender can take ownership of and liquidate to pay off the remaining balance in the event of a default. Unsecured LOC on the other hand can be obtained without collateral; this means that when the company defaults on the financing, the lender will have no pledged securities to use to recoup any losses.
What are Revolving and Non-Revolving Lines of Credit
A revolving line of credit refers to a bank or merchant providing an individual or company with a set amount of accessible credit for an indefinite period. A credit limit is set, money can be used for various reasons, interest is paid as usual, and payments can be made at any time. The loan is repaid regularly, and once paid off, it can be borrowed again.
A non-Revolving LOC is similar to a Revolving LOC except that after you have paid off a non-revolving line of credit, you will not be able to use it again. After payments have been paid, the credit pool does not replenish. When you pay off a non-revolving line of credit, the account closes and you can’t use it again.
Types of Lines of Credit (LOCs)
For many occasions or unanticipated occurrences, such as finishing home improvements, paying for a child’s education or obtaining additional cash flow for a business, lines of credit can be a beneficial financing alternative. The types of LOC’s are discussed below.
Personal Line of Credit
A personal line of credit may be used for almost any purpose. You draw from a line of credit up to a particular amount rather than getting one-time money like you would with a personal loan. Only when money is withdrawn does interest accumulate. Borrowers withdraw up to the debt limit on this form of revolving credit, which is comparable to a credit card, and then repay to draw on the line again. Interest rates are comparable to personal loans, and durations range from one to seven years depending on the lender. Opening a person line of credit
Home Equity Line of Credit (HELOC)
If the value of your property exceeds the amount owed on your mortgage, you may be eligible to borrow against the equity. A home equity line of credit is a form of loan that uses your property as collateral. This type of credit line is generally greater in size and has lower interest rates than other financing alternatives because it is secured by your house.
Demand Line of Credit
Using a demand LOC, the lender can demand full payment of the borrowed amount at whatever time they please. Payments made before the lender demands full payment of the actual loan are either made alongside the interest or the actual borrowed amount. This depends on the agreement binding for the Line of Credit.
Securities-backed Line of Credit
A Securities Backed Line of Credit (SBLOC) is a comparable loan that allows you to borrow against the value of your investment portfolio without having to sell the securities. Usually an SBLOC investor can borrow between 50% to 95% of the value of assets in their account. A revolving line of credit secured by the value of assets in a brokerage account is known as an SBLOC. Only after-tax investment accounts are eligible for SBLOCs.
Business Line of Credit
One of the most pressing problems for entrepreneurs and small company owners is cash flow. A business line of credit might help you get your company up and running. This sort of loan is typically used to support working capital or short-term financing needs, such as inventory purchases, tax payments, vendor payments, or payroll.
What are the Limitations of Lines of Credit
The major limitation of a LOC is that it is difficult to receive a raise if you need more money. If your business is developing rapidly and you have hit your credit limit, this restriction might be a major concern.
Confirm the Purpose for Your Line of Credit Before Obtaining One
Determine your actual goal for obtaining finance before rushing into a line of credit. Do you have a well-established business and are seeking the most cost-effective financing? If that is the case, a line of credit is your best option. Consider alternatives if you have a growing firm and want the most flexibility. These options, however, are more expensive than a line of credit.