S.

S JAIN SUBODH MANAGEMENT INSTITUTE

Term Paper
MBA: Third Semester
BANK AND FINANCE

Prepared By: Submitted to:

Piyush Sharma Meenal
Sukhlecha
Roll No: 29
PREFACE:
A line of credit (LOC) is a preset borrowing limit that can be tapped into at any time. The
borrower can take money out as needed until the limit is reached, and as money is repaid, it
can be borrowed again in the case of an open line of credit.
It is very crucial for today’s lending system and is increasing with passage of time.
CONTENT:

TOPIC Page no.

What Is a Line of Credit (LOC)? 4

Understanding Credit Lines 5
Types of Lines of Credit 6-7
What Is a Line of Credit (LOC)?
A LOC is an arrangement between a financial institution—usually a bank—and a client that
establishes the maximum loan amount the customer can borrow. The borrower can access
funds from the line of credit at any time as long as they do not exceed the maximum amount
set in the agreement.
The Line of Credit is a blessing for those who need financial aids at regular intervals. In this
system, the borrower can apply for a particular loan amount from a bank but he or she
needn’t take the entire amount in one shot. Once the loan amount is approved, the borrower
can take a small amount out of the entire fund for present need and keep the remaining
amount with the bank. The interest will be charged only on the amount that the borrower has
withdrawn and not on the entire amount. As a result, the customer can manage his or her
monthly expenses easily without getting burdened with the loan EMI
In this lending system, the borrower also has to pay lower interest rate compared to a
traditional loan. It is like a credit card where you can pay the charges only for the amount that
you have used and not for the entire credit limit.
Suppose, the bank has sanctioned Rs50,000 to you based on your LOC application and from
the approved amount you have taken out Rs10,000 as per your requirement. In such an
instance, you have to pay the interest amount for only Rs10,000 and not for the total amount.
Understanding Credit Lines
All LOCs consist of a set amount of money that can be borrowed as needed, paid back and
borrowed again. The amount of interest, size of payments, and other rules are set by the
lender. Some lines of credit allow you to write checks (drafts) while others include a type of
credit or debit card. A LOC can be secured (by collateral) or unsecured, with unsecured
LOCs typically subject to higher interest rates.

Unsecured vs. Secured LOCs

Most lines of credit are unsecured loans. This means the borrower does not promise the
lender any collateral to back the LOC. One notable exception is a home equity line of credit
(HELOC), which is secured by the equity in the borrower's home. From the lender's
perspective, secured lines of credit are attractive because they provide a way to recoup the
advanced funds in the event of nonpayment.
For individuals or business owners, secured lines of credit are attractive because they
typically come with a higher maximum credit limit and significantly lower interest rates than
unsecured lines of credit. Unsecured lines of credit are also more difficult to obtain and often
require a higher credit score or credit rating. Lenders attempt to compensate for the increased
risk by limiting the number of funds that can be borrowed and by charging higher interest
rates. That is one reason the annual percentage rate (APR) on credit cards is so high.

Revolving vs. Non-Revolving Lines of Credit

A line of credit is often considered to be a type of revolving account, also known as an open-
end credit account. This arrangement allows borrowers to spend the money, repay it, and
spend it again in a virtually never-ending, revolving cycle. Revolving accounts such as lines
of credit and credit cards are different from installment loans such as mortgages and car
loans.
With installment loans, consumers borrow a set amount of money and repay it in equal
monthly installments until the loan is paid off. Once an installment loan has been paid off,
consumers cannot spend the funds again unless they apply for a new loan.
Non-revolving lines of credit have the same features as revolving credit (or a revolving line
of credit). A credit limit is established, funds can be used for a variety of purposes, interest
is charged normally, and payments may be made at any time. There is one major exception:
The pool of available credit does not replenish after payments are made. Once you pay off
the line of credit in full, the account is closed and cannot be used again. 1
As an example, personal lines of credit are sometimes offered by banks in the form of
an overdraft protection plan. A banking customer can sign up to have an overdraft plan
linked to his or her checking account. If the customer goes over the amount available in
checking, the overdraft keeps them from bouncing a check or having a purchase denied.
Like any line of credit, an overdraft must be paid back, with interest.

Types of Lines of Credit:

LOCs come in a variety of forms, with each falling into either the secured or unsecured
category. Beyond that, each type of LOC has its own characteristics.

Personal line of credit:

This provides access to unsecured funds that can be borrowed, repaid, and borrowed again.
Opening a personal line of credit requires a credit history of no defaults, a credit score of
670 or higher, and reliable income. Having savings helps, as does collateral in the form of
stocks or CDs, though collateral is not required for a personal LOC. Personal LOCs are used
for emergencies, weddings and other events, overdraft protection, travel and entertainment,
and to help smooth out bumps for those with irregular income.

Home equity line of credit (HELOC)

HELOCs are the most common type of secured LOC. A HELOC is secured by the market
value of the home minus the amount owed, which becomes the basis for determining the size
of the line of credit. Typically, the credit limit is equal to 75% or 80% of the market value of
the home, minus the balance owed on the mortgage.
HELOCs often come with a draw period (usually 10 years) during which the borrower can
access available funds, repay them, and borrow again. After the draw period, the balance is
due, or a loan is extended to pay off the balance over time. HELOCs typically have closing
costs, including the cost of an appraisal on the property used as collateral.

Demand line of credit:

This type can be either secured or unsecured but is rarely used. With a demand LOC, the
lender can call the amount borrowed due at any time. Payback (until the loan is called) can
be interest-only or interest plus principal, depending on the terms of the LOC. The borrower
can spend up to the credit limit at any time.

Securities-backed line of credit (SBLOC):

This is a special secured-demand LOC, in which collateral is provided by the borrower’s
securities. Typically, an SBLOC lets the investor borrow anywhere from 50% to 95% of the
value of assets in their account. SBLOCs are non-purpose loans, meaning the borrower may
not use the money to buy or trade securities. Almost any other type of expenditure is
allowed.
SBLOCs require the borrower to make monthly, interest-only payments until the loan is
repaid in full or the brokerage or bank demands payment, which can happen if the value of
the investor’s portfolio falls below the level of the line of credit.

Business line of credit:

Businesses use these to borrow on an as-needed basis instead of taking out a fixed loan. The
financial institution extending the LOC evaluates the market value, profitability, and risk
taken on by the business and extends a line of credit based on that evaluation. The LOC may
be unsecured or secured, depending on the size of the line of credit requested and the
evaluation results. As with almost all LOCs, the interest rate is variable.