Line of Credit - Know Meaning, Definition, Types & Advantages

Similar to credit cards, a personal line of credit is a revolving credit account that lets you borrow up to a limit, without having to borrow the full amount at a go. They can be used in almost anything and is suitable for borrowers who may need funds, but at different points of time. 

However, compared to personal loans and credit cards, a personal line of credit carries a lower interest and gives variable access of funds to users. Let’s know about the personal line of credit in detail and how it works.

What is a Line of Credit?

A line of credit is an unsecured and ready source of funds, which can be used for business as well as personal needs. The borrower can withdraw funds from the line of credit loan account either through bank transfer or line of credit cheques. Every borrower is allotted a credit limit for the term of the loan and can withdraw from that as many times as the borrower wants.

The loan withdrawn must be repaid-with interest on the outstanding balance as per the terms of the lender and preset repayment schedule. During the term of the personal line of credit facility, the borrower can also increase the credit limit, based on his/her usage pattern and credit profile.

Line of credit loan can be taken for meeting home improvement expenses, medical expenses, or funding for a child’s education.

Must Read: Simple Ways to Choose the Right Personal Loan Tenure

Different Types of Lines of Credit

Lines of credit are broadly classified into two categories:

• Secured Line of Credit
  In this particular line of credit, you have to pledge your assets to get the line of credit loan. Failure to pay the amount borrowed, the lender will liquidate your assets to cover the losses. SMFG India Credit’s Loan against Securities is an example of such a credit line. 
• Unsecured Line of Credit
  Under this type, you don’t have to pledge collateral to open a line of the credit loan account. The lender extends the facility based on your eligibility and their own policy. Compared to the secured line of credit, the lender charges a higher rate of interest for this category. 

The unsecured line of credit is further classified into two categories:

1. Business Line of Credit
   The business line of credit is the most common type of line of credit availed by businesses to meet the business expenses of an ongoing nature such as working capital requirements, wage payments, inventory etc.
2. Personal Line of Credit
   This type of facility is availed by individuals to meet urgent expenses or long-drawn expenses such as funding big purchases, home renovation, child education, or meeting sudden financial requirements etc.  

It is offered to individuals with a high credit score (above 700) good credit history, with a favorable debt utilization ratio. 

How Does the Personal Line of Credit Work?

Personal LOC is a very flexible credit option for individuals and allows withdrawals according to the requirement of the borrower. Further, the interest is only levied on the amount borrowed, not on the entire credit limit and there is no compulsion to use the entire line of credit.

The amount can be repaid at once or in minimum monthly payments spread across a tenure ranging from 2 months to 5 years or as per the terms of the lender.

Difference Between Personal Loan and Personal Line of Credit

Apart from sharing many similarities like providing an easy way of finance, unsecured credits, easy eligibility criteria and instant approval, there are few differences. Such as:

• Personal LOC is revolving credit, whereas personal loans are approved only once
• In a personal loan, the interest is charged on the whole amount that’s given upfront, but in the case of Personal LOC, the interest is levied on the outstanding amount
• A personal loan once paid off, the account is closed, whereas Personal LOC remains active

Advantages of Personal Line of Credit

• Lower interest rates
• High borrowing limit
• Cost-effective
• Flexible repayment option
• Constant access to funds
• Best for meeting long term project costs, temporary cash shortfalls and emergency

Allows for better planning, as you would have only borrowed the amount you actually need, and wouldn’t give in to impulse purchases at a later point in time

Disadvantages of Personal Line of Credit

• Annual maintenance charges
• Requires good credit score to qualify for the facility
• Not ideal for debt consolidation
• Risk of borrowing more due to easy access to funds

The inability to keep track in case of multiple withdrawals can lead to a messy financial situation.

Must Read: How to Apply for a Personal Loan Online

Should You Apply for Personal Line of Credit?

Personal LOC is an excellent financial tool but is not everyone. It is suitable for only those, who require constant access to funds due to an irregular or unpredictable set of requirements. Further, you need to have a good credit score to qualify for the facility and also to maintain the same. In an event of default, the lender may stop your personal LOC facility which will adversely affect your credit score.

If you require funds for a short term requirement, then a personal loan is the best option as they have less stringent eligibility criteria and a quick approval process. You can also apply for a personal loan online with all the necessary personal loan documents.