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Tata Capital > Blog > Personal Use Loan > Line Of Credit: Meaning, Types, And Benefits

Personal Use Loan

Line Of Credit: Meaning, Types, And Benefits

Line Of Credit: Meaning, Types, And Benefits

Introduction

In financial services, various borrowing options are available to individuals and businesses in India, each with unique features and advantages. One such option is a line of credit, which offers flexibility and convenience in accessing funds as needed.

This article delves into the meaning, types, and benefits of lines of credit and their limitations from an Indian perspective to help readers better understand this financial tool and make informed decisions.

What Is a Line of Credit?

A line of credit is a pre-approved amount of money that a borrower can access up to a specified limit as needed. Unlike traditional loans, which require the borrower to take a lump sum amount and repay it in instalments, a line of credit allows the borrower to withdraw funds as and when required, only paying interest on the amount used.

Understanding Credit Lines in India

To better comprehend credit lines, let's explore their key characteristics and how they function in the context of India.

Pre-approved Limit: A credit line is a pre-approved borrowing limit granted by a financial institution, such as a bank or non-banking financial company (NBFC). The approved limit is based on the borrower's creditworthiness, income, and collateral (if any). The borrower can access any amount up to this limit as needed without having to reapply for a new loan each time.

Flexibility: One of a credit line's main advantages is its flexibility. Borrowers can withdraw funds as needed and repay them at their own pace, subject to any minimum payment requirements. This makes credit lines particularly suitable for addressing unexpected expenses, managing cash flow gaps, or covering irregular expenses.

Interest Charges: A key feature of credit lines is that borrowers only pay interest on the amount they use rather than the full credit limit. Interest rates are typically variable and can change over time based on market conditions or the borrower's credit profile.

Repayment Structure: The repayment process for a credit line is also different from traditional loans. Borrowers are typically required to make minimum monthly payments, often including interest and a small portion of the principal. However, they can pay more than the minimum to reduce their balance faster.

Types of Lines of Credit

Loan Against Property (LAP): Similar to a Home Equity Line of Credit (HELOC) in other countries, a LAP is a secured line of credit that uses the borrower's property as collateral. The credit limit is usually determined by the property's equity amount, making it a popular option for financing home improvements, education, or other large expenses in India.

Overdraft Line of Credit: An overdraft line of credit is linked to the borrower's bank account, protecting overdraft fees and insufficient funds. When the account balance falls below zero, the line of credit is automatically activated to cover the shortfall up to the approved limit. The borrower pays interest on the overdraft amount and may also be charged an annual fee or other fees associated with the service.

Credit Card: A credit card is a common form of revolving credit line that allows individuals to make purchases, pay bills, or withdraw cash up to their credit limit. Interest is typically charged on outstanding balances if they are not paid off in full each month. Credit cards (revolving credit lines) may offer additional benefits, such as rewards programs, cashback, or travel perks, depending on the card issuer and the specific card product.

Trade Credit: Trade credit is a type of credit line extended by suppliers to businesses, allowing them to purchase goods or services on credit with deferred payment terms. This form of credit line enables businesses to manage their cash flow more effectively by delaying payments to suppliers until they have received payment from their customers.

Limitations of Lines of Credit

While lines of credit offer flexibility and convenience, they also come with certain limitations that borrowers should know before deciding if this financial tool is right for them.

Interest Rates: Lines of credit typically have variable interest rates, which can fluctuate over time. Borrowers may face higher interest rates than traditional loans, especially if they have a lower credit score.

Over-borrowing: Since lines of credit offer easy access to funds, borrowers may be tempted to use the funds for non-essential expenses, leading to excessive debt and financial strain.

Credit Impact: Borrowers who continuously draw on their line of credit and carry a high balance may see their credit score negatively impacted, as credit utilization is a significant factor in determining credit scores.

Fees: Some lines of credit may come with fees, such as annual fees, maintenance fees, or transaction fees, which can increase the overall cost of borrowing.

Risk of Reduced or Frozen Credit Limits: In certain circumstances, lenders may reduce or freeze a borrower's credit limit, potentially leaving them without access to funds when needed.

Conclusion

By understanding the various types of lines of credit, their potential benefits, and their limitations from an Indian perspective, borrowers can make informed decisions about whether a line of credit is the most suitable option for their specific financial needs.

One such example of a financial institution offering a range of lines of credit loans in India is Tata Capital. They provide customized credit solutions for individuals and businesses, catering to diverse financial needs and requirements.

With the advent of technology, financial institutions like Tata Capital now offer "Instant Line Of Credit Online" services, allowing borrowers to apply and receive approval quickly, further simplifying the process.

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