Ideologically, the line of credit or LOC and personal loan is the same. In both instances, clients can opt for a loan and pay it back in EMIs or equated monthly instalments. But the processes involved are different. This difference also gives rise to individual pros and cons, some of which are similar while some are dissimilar. Hence, before opting for either, gaining a thorough understanding is essential.

What is the line of credit?

A line of credit refers to a preset limit provided by a lender, like a bank, NBFC, financial institution etc., that can be tapped into at times of need. The lender sets a predefined limit up to which the borrower can keep withdrawing money. The total amount sanctioned can be withdrawn in one go or as multiple withdrawals. However, this arrangement only lasts till the sanctioned credit limit is not reached.

This in-built flexibility makes the LOC different from other loans. Borrowers are sanctioned a specific amount based on the rationality of their request. Further, borrowers can decide what portion of the sanctioned credit limit they want to use. They have the flexibility of tailoring their borrowing based on their needs. Interest is also charged for the amount that they borrow and not on the total credit limit sanctioned.

They also have the flexibility of paying off the current outstanding based on their cash flow. Hence, they can opt to clear off their entire dues all at once, make the minimum monthly payments required or keep paying off the money borrowed in small amounts along with the minimum monthly payments made.

Interest is also levied only on the principal borrowed. This gives the LOC a distinct advantage over other traditional forms of loans wherein interest starts accruing the moment the loan is disbursed.

Types of line of credit

There are many different types of LOCs. Some are secured LOCs, while others are unsecured. This means that to get a credit limit sanctioned, some types of LOCs might require collateral while others might not. Collaterals for a secured LOC can be in the form of property, investments, business assets etc. Typically these collaterals safeguard the lender from a potential loss, and hence the rate of interest levied on secured LOCs is relatively lower.

For an unsecured LOC, the lender sanctions a credit limit based on the applicant’s financial data like credit score, income and its stability, FOIR, debt-to-income ratio etc. With no collateral to provide a backup in case of repayment defaults, unsecured LOCs generally attract a higher rate of interest than secured ones.

Currently, almost all LOCs, secured or unsecured, can be divided into the following types.

● Personal line of credit: This is an unsecured LOC where customers can gain access to funds that can be borrowed, repaid at convenience and borrowed again if required. But to obtain this LOC, customers should have a credit history with no payment defaults, their credit score should be 670 or higher, and they should have a stable and reliable income.

This type of LOC is generally used for weddings, medical emergencies, overdraft protection, travel, education, entertainment etc.

● Home equity line of credit (HELOC): This is a common type of secured LOC. Here, the size of the LOC is determined by calculating the market value (MV) of the property offered as collateral minus the mortgage amount. Typically about 75% to 80% of MV minus the mortgaged amount is sanctioned. However, there are some costs associated with this type of LOC, like property appraisal costs, closure costs etc.

● Business line of credit: Lenders evaluate the profitability, the MV and the associated business risks to come to a conclusion regarding the credit limit to be sanctioned. The business line of credit can be secured or unsecured. The lender can ask for collateral if they so feel based on the LOC requested and evaluation of the business.

● Demand line of credit: While this type of LOC is rarely used, it can be secured or unsecured. Here, the lender is at liberty to call in the due borrowed amount at will. This increases the risk of the demand line of credit.

●Securities-backed line of credit (SBLOC): This is a special case of secured LOC wherein securities are provided as collaterals. Typically 50% to 95% of the asset value can be sanctioned. This loan is also a non-purpose loan which means that other than investing in securities, this LOC can be used to meet all other types of expenses.

The Tata Capital Emergency Credit Line Guarantee Scheme (ECLGS)

The ECLGS scheme is a term loan announced by the Finance Ministry for existing business enterprises and MSMEs to:

●        Build their current assets

●        Fulfil their requirement for working capital

●        Meet any operational crisis

●        Restart their business

This scheme was announced so businesses and MSMEs affected by the COVID-19 pandemic could overcome business-related economic distress.

Tata capital has made this scheme valid for all its existing TCHFL (Tata Capital Housing Finance Limited) and its TCFSL (Tata Capital Financial Services Limited) clients, provided they fulfil the main eligibility criteria. These include:

●Having a combined loan outstanding of up to Rs. 50 cr as of 29/2/2022 from all member lending institutions.

● An annual turnover of up to Rs. 250 cr FY 2019-20.

● Featuring a borrower account DPD that is less than 60 days as of 29/2/2022.

● Having a GST registration except in cases where they are not required to acquire the same.

This scheme has made it easy for Tata Capital clients and customers to revive their businesses since the scheme is backed by the Finance Ministry of India and comes with Tata assurance.

Conclusion

The availability of many different loan options might make a consumer feel overwhelmed and confused. Figuring out the best option to avail might seem like a daunting task. A clear understanding of the qualifying factors and repayment options will make it easier to gauge whether a particular loan type fits in with the borrower’s financial goals. However, the advantages associated with the LOC make it a slightly easier option to explore. The fact that it is easy to pay off the LOC makes it an option worth trying.

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