Ultimate Guide to Line of Credit and How It Works

Quick access to funds is crucial during a financial crisis and you can get immediate support from financial institutions. But what if you’re unsure about the exact amount you need? This is where you can rely on a Line of Credit (LOC).  

A LOC is not like a traditional loan. It gives you access to a pre-approved amount up to a specific limit and you can withdraw funds as and when needed. After repaying the withdrawn amount, you can borrow up to the limit again. Here’s all you need to know.  

Line of Credit Meaning, Types and Examples 

A line of credit means a flexible borrowing option where you get access to a certain amount of money and can use it whenever you need. You can repay the amount you use all at once or over time. 

You have to pay interest only on the borrowed amount and not on the entire approved limit.  

To approve you for a line of credit, the financial company will verify your credit score and overall financial history.  

For example, say Anika, a small business owner, applies for a LOC to manage her business expenses. Here are details:   

• Credit Limit: The bank approves a LOC of ₹5,00,000.  

• Usage: She can use the fund as she needs. For instance, if she withdraws ₹1,50,000, she pays interest only on the ₹1,50,000 she uses, and not on the entire ₹5,00,000.  

• Repayment: She repays ₹1,00,000 after a few weeks.  

• Available Balance: The available credit now stands at ₹4,50,000, with ₹50,000 still outstanding.  

• Ongoing Access: She continues to borrow and repay within the approved limit multiple times.  

There are two types of lines of credit: secured and unsecured. They are different from each other in the following ways: 

Secured LOC	Unsecured LOC
Backed by collateral, such as property	Doesn’t require collateral
Lower rate of interest as per borrower’s eligibility	Often comes with a higher rate of interest as per the borrower’s eligibility
Higher credit limit as per borrower’s eligibility	Lower credit limit as per borrower’s eligibility

Benefits of a Line of Credit  

LOC comes with multiple advantages such as: 

• Flexible Use: Withdraw and repay multiple times as per needs  

• Save on Interest: Pay interest only on what you use, not the full limit 

• No Foreclosure Fees: Close your loan early without extra charges (based on the financial institution’s policies) 

Potential Drawbacks 

A line of credit can be helpful, but poses certain risks: 

• Risk of Overspending: Easy access to funds may lead to overspending and higher debt 

• Variable Interest Rates: Interest rates can go up anytime, and this can end up making repayment harder 

• Risk of Losing Assets: If you take a LOC secured by an asset and cannot repay, you may stand to lose it 

• Insufficient Limit: The approved limit may not be sufficient to fulfil long-term needs 

Line of Credit vs. Other Borrowing Options 

There are different kinds of borrowing methods available. Here’s a comparison table to help you understand which one might suit you most: 

Aspect	LOC	Credit Card	Loan
Type	Revolving credit limit	Revolving credit limit	One time lump-sum amount
Interest Charges	On the borrowed amount	On the outstanding balance	On the total amount
Access to Funds	Withdraw as needed within the limit	Continuous access up to the credit limit	Full amount disbursed upfront
Flexibility	Highly flexible	Flexible for small and frequent purchases	Less flexible

A line of credit has both advantages and disadvantages. On one hand, it can be an affordable way to cover unpredictable expenses. On the other hand, using a LOC without careful planning can cause financial strain. If you are looking for another option, consider the Fibe Instant Loan which offers flexible repayment options for up to 36 months. To get up to ​​₹5 lakhs in just 2 minutes, download the Fibe App.  

FAQs on Line of Credit 

Is it a good idea to get a line of credit? 

A LOC comes with lots of benefits for those who want to handle unexpected expenses and are not sure how much they need. With LOC, you can withdraw your chosen amount from the limit multiple times and repay when you can. The best part about LOC is that you only have to pay interest on the borrowed amount instead of the full sanctioned amount.  

What is the disadvantage of a line of credit? 

Potential downsides include: 

• High interest rates 

• Late payment fees 

• Potential to spend more than you can afford to repay 

What happens if I don’t use my line of credit? 

The policies for not utilising the funds from a line of credit depend on the institution. Sometimes, a non-usage fee may be charged. However, you are still liable to pay interest on the money you borrowed until it is repaid.