In its most basic meaning, a credit line – also known as a line of credit (abbreviated LOC) is a form of credit extended to a business or to an individual by a bank or by any other type of financial institution. As many of you already know, credit is a form of borrowing that refers to the provision of resources by one party (the lender or creditor) to another (the borrower or debtor). The borrower does not reimburse the lender as soon as after the credit is granted, but repays the debt (which can range from thousands to hundreds of thousands of dollars) at a later date, either in full or in installments, as agreed beforehand. A credit line takes the form of an account via which a certain amount of money is made available by the lender to the borrower, so that the latter can readily tap into it should the need arise, mostly by withdrawing the cash upfront. Interest for a credit line is only paid on the money actually taken out.
In many ways, the credit lines and the credit cards are similar – yet we don’t see the banks to advertise credit lines with the same enthusiasm that they put (or, better said, that they used to put) behind credit card advertisements. The main reason for this is that credit lines mainly target business customers as their main purpose is to assist the borrowers in covering any impending liquidity problems; however, individual consumers who fulfill the banks’ ever-tightening crediting terms can access a credit line, should they wish to. A credit line is essentially an unsecured open-end credit product that provides access to revolving credit. However, unlike a credit card, it does not come with a “grace period” in which no interest is charged for the amount withdrawn.
The generally principle is that credit cards are designed to be better for consumers who carry out day-to-day purchases, while lines of credit are better for cash advances and usually (but not exclusively) target businesses. Under these circumstances, when an individual takes out a line of credit, it is referred to as a personal line of credit, while as far as businesses are concerned, the line is referred to as a business line of credit.
For businesses wishing to gain access to a line of credit, an arrangement must be drawn out with the lender (the bank) to establish a maximum loan balance that the bank will permit the borrower to maintain. The amount of the balance depends on many factors, and of course, the higher the maximum solicited loan balance is, the tighter the conditions banks will impose on business borrowers. Among the basic prerequisites for a business line of credit approval are a strong credit history, a good relationship with the bank in question and solid, verifiable earnings.
The credit line
For a business, a credit line may take several forms such as cash credit, demand loan or term loan. The term cash credit refers to a short-term cash loan given to an organization by a bank. However, in the case of this particular type of credit line, the borrower (bank or other financial services provider) grants access to the funds only after some type of security is given in order to secure the loan. Once a security for repayment has been given, the business that receives the loan can draw from the credit line on a continuous basis, up to a certain specified amount. Depending on the agreement with the financial institution, the line of credit may also be classified as a demand loan. Such a loan can come with or without a fixed maturity date, however, its main feature is that it can be recalled at any time by the lender (usually with a 24-hour notice) and must be paid in full on the date of demand. What this means is that that any outstanding balance must be paid immediately at bank’s express request. A demand loan is also referred to as a call loan or money at call. Finally, a credit line may take the form of an asset based short-term loan payable in a fixed number of equal installments over a pre-defined term, usually between one and five years. Term loans are usually provided as working capital for businesses looking to acquire assets such as machinery or equipment that will ultimately generate the cash flow needed to repay the loan.
As far as personal credit lines are concerned, they can be very useful financial tools, provided that they are used cautiously. A personal credit line can be seen as an attractive borrowing alternative to credit cards and to regular loans, mainly because the banks only charge interest on the part of the line of credit that is used. Usually, no interest is charged for the portion of the credit line that is not employed by a consumer. Borrowers who open a personal line of credit can tap the credit line whenever they need cash, provided they do not exceed the pre-defined maximum loan balance. Depending on the institution, consumers can access the money via checks, online transfers, ATMs or via their local bank branches.
The credit line
Despite their advantages, the personal lines of credit may prove difficult to access, particularly in the present economic climate. To be granted a credit line, consumers need very good credit scores and a solid credit history. Also, interest rates for personal credit lines tend to be higher compared the rates charged on home equity lines of credit. There are also certain limitations with regard to the maximum balances available via personal credit lines. Typically, even with a stellar credit score and good credit history, most banks will approve credit lines worth USD 10,000 or less. For credit lines worth between USD 10,000 and USD 50,000, much more rigorous verifications are carried out, and the list of criteria applicants must fulfill grows longer. At that point, the required paperwork needed for the approval of a credit line may include tax returns and documentation of personal assets. Typically, bank surveys have shown that consumers who have personal credit lines repay the money in 12 to 18 months and employ the funds to pay for educational and medical expenses, cars or home improvements or to consolidate high-interest debt.
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