Generally, when entrepreneurs think of accessing funds, they tend to think of credit cards, bank loans or even dilution of equity. However, there is another method that is simply not so well known; a line of credit that can be very useful for accessing money especially when you need it quickly to attend to a business opportunity or even to get unexpected repairs done to plant and machinery urgently. A line of credit is a far smarter option to access loans at costs that are far more budget-friendly though most banks don’t publicize this avenue at all.
What Exactly Is A Line of Credit?
A line of credit or simply LOC is a type of loan extended by banks that allows you to borrow money for a specified purpose that is declared to the bank. Entrepreneurs experiencing problems of cash flow or not having the collateral for inventory when starting a business venture can use a line of credit to obtain the much-needed leverage. A line of credit differs from a conventional bank loan in a significant way. When you take a traditional bank loan, you receive the loan proceeds at one go and you are required to start making the repayments from the next month onwards. A line of credit allows you to borrow only as much money as you immediately need even if the amount approved for you is significantly more. You are required to pay only the interest and the applicable fees on the amount utilized and not on the limit sanctioned. However, the entire amount up to the limit approved is available for you to borrow at any point in time.
How Does A Line of Credit Really Work?
A line of credit is remarkably similar to a credit card. You have the flexibility to use funds up to the limit sanctioned but you pay only for what you utilize. The significant advantage that a line of credit has over a credit card is that the rate of interest is far lower. Additionally, the line of credit typically has a much higher limit in comparison with the credit card limit. As in a credit card, you will receive a monthly statement that shows the balance, the minimum due payment together with a summary of the interest and fees. The repayments are to be made monthly as per the agreement with the bank.
What Are the Different Types of Lines of Credit?
Essentially, there are two categories of credit; unsecured and secured. As is evident from the nomenclature, a secured line of credit is backed by physical assets acting as collateral; typically, land, vehicles, boats, homes, and such like that can be sold off by the bank to realize its dues in case of borrower default. Not only do secured lines of credit carry a lesser rate of interest but also it is easier to obtain due to obvious reasons. The other type is the unsecured line of credit that is not backed by any tangible security. Consequently, the approval process of the bank is more stringent, and the rate of interest is comparatively higher due to the higher risk perception.
What Are the Different Types of Lines of Credit Based on The Usage?
Business Lines of Credit: A line of credit represents an economic way of funding short-term business requirements such as operating expenses, inventory purchase, and new equipment purchase, payment of staff salaries or expenses that your current cash flow does not permit. A business line of credit is the perfect funding tool if you are the owner of a startup in its early phase as it is very handy in lending more consistency to the cash flow that is often required to meet costs that are sudden and quite unexpected. It is usual for business lines of credit to be secured by business assets like plant and machinery, equipment or inventory.
According to https://www.inc.com, “the review process banks use can be cumbersome as well. Your bank may require financial statements, business and personal tax returns, business documents, and existing bank account information, among other things. You’ll probably need two years of business history to qualify and also undergo a yearly review.”
Home Equity Lines of Credit: These lines of credit are securitized by your home and hence the rate of interest is low. Typically, HELOCs are availed of to fund home repairs and extensions or to pay off existing debts. You can apply to your mortgage lender for a HELOC, which will come with a set timeline for both the withdrawal and repayment of the funds. If your debts are really out of hand, you can consider using the services of debt settlement companies like National debt relief programs.com.
Personal Lines of Credit: A personal line of credit may be obtained from a bank to meet personal expenses, the nature of which does not usually have to be provided to the bank. In case, you can offer any physical assets as collateral, you will be able to get it at a lower rate of interest than if you were to apply for it without offering any backing security. Normally, personal lines of credit can be availed of at the bank that you have a checking account with. In fact, it is a requirement of all banks for borrowers to have a checking account with that bank to enable transfers into your account or even issuing checks for any purchases that you might be making. Generally, personal lines of credit are given to customers who have had a stable banking relationship with the concerned bank. Remember that while the bank will not ask for details regarding the usage of the funds, it can seize the collateral assets in case of default.
Just like conventional loans, lines of credit are given based on the evaluation of the borrower’s credit score, as well as, the financial standing. It is important for you to review your credit reports and your business finances so that no inaccuracies can spoil your chances of getting the desired line of credit. Shopping around can also help you to take advantage of the competitive market forces. Borrow only as much as your cash flow will permit to prevent the chance of default.