All Learning | What is a line of credit?

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What is a line of credit?

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Praveen Sudha

February 9, 2021
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Whenever people need money, seeking a line of credit is usually the last option they can opt for. A line of credit is basically the preset amount of money that a bank agrees to lend an individual. The person can draw from the line of credit whenever he needs it up to the maximum limit set and further, he’ll have to pay interest on the amount he has borrowed.  

So, the line of credit grants people access to money “on demand” and helps them with expenses such as unplanned car maintenance or a home project. The line of credit is offered by lenders like credit unions or banks and if the individual qualifies it, he can easily avail of the maximum amount for the set time period.  

How a line of credit works? 

Whenever an individual applies for a line of credit, having a good credit score is quite helpful in qualifying for a lower annual percentage rate and few lines of credit charge annual fees and have limits on the amount that can be borrowed. Once the person qualifies for the line of credit, he gets a particular time frame, which is referred to as the ‘draw period’ under which he can draw money from the account. The draw period can last for a number of years.                        

Once the person borrows the money from his line of credit, interest beings to accrue and he’ll need to begin making at least minimum payments. This amount is added back to his available line of credit as he makes it; however, as his draw period ends, the person enters the repayment period, where he’ll have a set time to pay off any remaining balance. In case the person keeps on paying the only minimum payment, be prepared to pay more interest in the long run. 

Secured V/S Unsecured Lines of Credit 

In a secured line of credit, the account holder needs to give some valuable asset (in the form of property, company, or some equipment) as collateral for getting the credit. In that case, the valuable asset must be equal to or more than the value of LOC’s maximum limit. Secured lines of credit ensure higher credit limits and competitive interest rates as there is no risk in this scenario. Under a secured line of credit, in case a business defaults on payments and the lender seizes the collateral, the borrower has the authority to designate his assets for possession. 

In an unsecured line of credit, the borrower doesn’t have to provide any collateral and it is ideal for businesses who need smaller credit limits up to $100,000 as it has lower maximum limits and higher interest rates. Under an unsecured line of credit, the lender can seize personal assets for the outstanding payments if the borrower fails to provide the funds. 

Who can qualify for a business line of credit? 

In order to qualify for a business line of credit, the company owner must show give evidence of having a minimum of $50,000 in annual revenue, a personal credit score of 550 at least, and must have at least one year in business. Businesses with lower credit history can apply for a short-term line of credit and these options are helpful for improving a business’s creditworthiness so that they can qualify for long-term lines of credit in the time ahead. 

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