More often than not, most of us are faced with an emergency that requires urgent credit. This can be paying your monthly bills, or for a vacation trip, you got recently excited for or any health-related issue requiring quick cash. Quick credit from friends, family or financial institutions has always proven to be helpful in such scenarios.
Ever wondered about getting the benefits of a traditional bank loan but with no minimum amount and interest charges being levied as per amount used? Yes, that’s called a Line of Credit.
Line of Credit is a financial instrument where you have access to money on demand. The amount is prefixed, but you can loan the amount as per your requirement. The best part is you pay interest only after you start using the amount.
Interest free loans and credit cards also operate in a similar fashion as the Line of credit, which has a pre-decided fixed tenure when no interest rate is charged on the loan amount.
A credit score or CIBIL score is a reflection of your credit behaviour. Your credit score has a considerable weightage on the issuance of the line of credit.
The credit score ranges from 300-900. A score above 750 is considered ideal for getting a loan approved at favourable terms.
Lines of credit are mostly revolving (open-end accounts) and continually allow you to draw money up to the limit as long as repayments are made. Non-revolving (closed-end accounts) on the other hand, don’t allow withdrawals once the outstanding balance of the line of credit has been paid.
Types of Line of Credit
Broadly put, there are two types of line of credit:
#1. Secured Line of Credit –
This is very similar to secured loans where you get a secured line of credit against an asset. The lender can seize your asset if there is any default in the payment.
Since a secured line of credit is backed by an asset, its interest rates are very low. This also means being a line of credit and asset-backed, it can provide a continuous flow of money as and when needed against that very asset value.
#2. Unsecured Line of Credit –
Fairly similar to an unsecured loan, here you get access to unsecured LOC based on your credit history and credit score. The borrower’s repayment history is considered as a security. These LOCs do not have any asset involved as security.
They are relatively more difficult to secure and mostly require a higher credit score or credit rating. Lenders are very careful while issuing such LOC as once the payment has defaulted, there is technically nothing the issuer can seize in compensation.
Credit cards are an ideal example of a line of credit in which the parameters such as interest rate and maximum limit are decided beforehand.
Applying for a Line of Credit
Application for a line of credit is carried out through a bank or financial institution willing to lend money. The lender seeks information about the borrower and checks his or her credit history. The lender/bank can issue or reject the line of credit on the basis of the documents mentioned below.
The documents that need to be kept handy while seeking a line of credit are identity proof, proof of employment, proof of residence, proof of income, proof of age, bank statements of past few months, PAN Card, & Aadhar Card.
The interest rate and repayment cycle is decided and mutually agreed upon. The rate of interest largely depends on your credit history and monthly income. Make sure to check the activation fee, joining fee, interest rate, annual fee and taxes, wherever applicable.
Can I Increase the Credit Limit in Line of Credit?
Yes, your line of credit can definitely be increased based on your previous repayment history. This may affect your credit scores as increasing the line of credit triggers your creditworthiness and hence may call for detailed scrutiny of your past payments.
Maintaining a healthy repayment schedule will automatically make you eligible to increase your line of credit from your bank or financial institution. You will be considered as a good customer who doesn’t miss out on timely repayments.
One of the best ways to ensure a good credit score is by paying your dues on time. Set reminders or automate your payments if needed. Alas, the best way to check whether your LOC can be increased or not, is by directly reaching out to your lender.
Making the most out of a Line of Credit
Plan ahead of what you want to do with your line of credit and at what intervals you want to use it. With a line of credit, people tend to lose track of payments as it is easy to keep withdrawing from the account.
Choose a repayment cycle that suits you. Take into account your monthly income and how much you can repay while staying within your financial limits.
Ensure that you never need to use credit cards instead to repay your line of credit. This will only lead to a vicious credit cycle and land you in a debt trap.
Explore all options like different banks or institutions before finalising on your line of credit, and negotiate on your repayment cycle & interest rates. No credit check loans are also emerging lately and can be considered, as well.
Extra precautions must be taken when opting for a secured line of credit and must be exercised if you really need it. Improper repayments will lead to lower credit ratings, decreased line of credit in future and in worst cases such as faulty or absence of repayment plan, your valuable assets being shelled out by the lender.
Every financial instrument comes with its downsides as well, and line of credit is no exception. People who are not financially disciplined, tend to make unnecessary purchases which take a toll on their financial health and highly reduce their credit rating.
Clarity about closing and maintenance costs will help during repayments and line of credit closure. Some banks and financial institutions may also charge an annual fee in addition to closing fees. It is best to be clear about the same during your line of credit application.
With proper planning and understanding, you can benefit from a line of credit and manage your finances well. Also, don’t forget to keep track of your spending to ensure controlled spending.